Document
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________________________________________
FORM 10-Q

x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
or
¨  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from            to            

Commission File No. 000-51754
_____________________________________________________________
CROCS, INC.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
 
20-2164234
(I.R.S. Employer
Identification No.)
7477 East Dry Creek Parkway, Niwot, Colorado 80503
(Address, including zip code, of registrant’s principal executive offices)
(303) 848-7000
(Registrant’s telephone number, including area code)
_____________________________________________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x   No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x   No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ý
Accelerated filer o
Non-accelerated filer o
 (do not check if a
smaller reporting company)
Smaller reporting company o
Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨   No x

As of October 31, 2017, Crocs, Inc. had 69,667,827 shares of its $0.001 par value common stock outstanding.
 



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Cautionary Note Regarding Forward-Looking Statements
 
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). From time to time, we may also provide oral or written forward-looking statements in other materials we release to the public. Such forward-looking statements are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995.

Statements that refer to industry trends, projections of our future financial performance, anticipated trends in our business and other characterizations of future events or circumstances are forward-looking statements. These statements, which express management’s current views concerning future events or results, use words like “anticipate,” “assume,” “believe,” “continue,” “estimate,” “expect,” “future,” “intend,” “plan,” “project,” “strive,” and future or conditional tense verbs like “could,” “may,” “might,” “should,” “will,” “would,” and similar expressions or variations. Examples of forward-looking statements include, but are not limited to, statements we make regarding:

our expectations regarding future trends, expectations and performance of our business;
our belief that we have sufficient liquidity to fund our business operations during the next twelve months;
our expectations about the impact of our strategic plans; and
our expectations regarding our level of capital expenditures in 2017.

Forward-looking statements are subject to risks, uncertainties and other factors, which may cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation, those described in the section entitled “Risk Factors” under Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2016, and our subsequent filings with the Securities and Exchange Commission. Caution should be taken not to place undue reliance on any such forward-looking statements. Moreover, such forward-looking statements speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.
 


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Crocs, Inc.
Table of Contents to the Quarterly Report on Form 10-Q
For the Quarterly Period Ended September 30, 2017
 
PART I — Financial Information
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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PART I — Financial Information
 
ITEM 1. Financial Statements
 
CROCS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(in thousands, except per share data)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017

2016
 
2017
 
2016
Revenues
$
243,273

 
$
245,888

 
$
824,401

 
$
848,856

Cost of sales
119,810

 
123,454

 
397,547

 
427,416

Gross profit
123,463

 
122,434

 
426,854

 
421,440

Selling, general and administrative expenses
120,778

 
123,649

 
379,141

 
387,807

Income (loss) from operations
2,685

 
(1,215
)
 
47,713

 
33,633

Foreign currency gain (loss), net
(257
)
 
1,379

 
181

 
(1,568
)
Interest income
269

 
178

 
576

 
558

Interest expense
(167
)
 
(184
)
 
(539
)
 
(661
)
Other income (expense)
54

 
(1
)
 
187

 
(108
)
Income before income taxes
2,584

 
157

 
48,118

 
31,854

Income tax expense
955

 
1,690

 
13,519

 
7,704

Net income (loss)
1,629

 
(1,533
)
 
34,599

 
24,150

Dividends on Series A convertible preferred stock
(3,000
)
 
(3,000
)
 
(9,000
)
 
(9,000
)
Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion feature
(892
)
 
(819
)
 
(2,621
)
 
(2,406
)
Net income (loss) attributable to common stockholders
$
(2,263
)
 
$
(5,352
)
 
$
22,978

 
$
12,744

Net income (loss) per common share:
 

 
 

 
 
 
 
Basic
$
(0.03
)
 
$
(0.07
)
 
$
0.26

 
$
0.15

Diluted
$
(0.03
)
 
$
(0.07
)
 
$
0.26

 
$
0.14

 
 
 
 
 
 
 
 
Weighted average common shares outstanding - basic
71,895

 
73,493

 
73,212

 
73,323

Weighted average common shares outstanding - diluted
71,895

 
73,493

 
74,160

 
74,730

 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


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CROCS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
(in thousands)
  
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net income (loss)
$
1,629

 
$
(1,533
)
 
$
34,599

 
$
24,150

Other comprehensive income (loss):
 

 
 

 
 
 
 
Foreign currency gain (loss), net
4,124

 
(140
)
 
11,589

 
6,531

Total comprehensive income (loss)
$
5,753

 
$
(1,673
)
 
$
46,188

 
$
30,681


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.



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CROCS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except share and par value amounts)
 
September 30,
2017
 
December 31,
2016
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
178,189

 
$
147,565

Accounts receivable, net of allowances of $49,360 and $48,138, respectively
92,708

 
78,297

Inventories
140,282

 
147,029

Income tax receivable
7,421

 
2,995

Other receivables
14,547

 
14,642

Restricted cash - current
2,175

 
2,534

Prepaid expenses and other assets
24,416

 
32,413

Total current assets
459,738

 
425,475

Property and equipment, net of accumulated depreciation and amortization of $95,512 and $88,603, respectively
38,412

 
44,090

Intangible assets, net
66,505

 
72,700

Goodwill
1,663

 
1,480

Deferred tax assets, net
7,098

 
6,825

Restricted cash
2,895

 
2,547

Other assets
13,342

 
13,273

Total assets
$
589,653

 
$
566,390

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
55,181

 
$
61,927

Accrued expenses and other liabilities
84,836

 
78,282

Income taxes payable
14,096

 
6,593

Current portion of borrowings and capital lease obligations
1,070

 
2,338

Total current liabilities
155,183

 
149,140

Long-term income tax payable
4,926

 
4,464

Long-term capital lease obligations
35

 
40

Other liabilities
13,931

 
13,462

Total liabilities
174,075

 
167,106

Commitments and contingencies


 


Series A convertible preferred stock, 1.0 million authorized, 0.2 million shares outstanding, liquidation preference $203 million
181,522

 
178,901

Stockholders’ equity:
 

 
 

Preferred stock, par value $0.001 per share, 4.0 million shares authorized, none outstanding

 

Common stock, par value $0.001 per share, 94.7 million and 93.9 million issued, 71.0 million and 73.6 million shares outstanding, respectively
95

 
94

Treasury stock, at cost, 23.7 million and 20.3 million shares, respectively
(311,302
)
 
(284,237
)
Additional paid-in capital
370,567

 
364,397

Retained earnings
218,703

 
195,725

Accumulated other comprehensive loss
(44,007
)
 
(55,596
)
Total stockholders’ equity
234,056

 
220,383

Total liabilities and stockholders’ equity
$
589,653

 
$
566,390

 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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CROCS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
 
Nine Months Ended September 30,
 
2017
 
2016
Cash flows from operating activities:
 

 
 

Net income
$
34,599

 
$
24,150

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation and amortization
24,701

 
25,473

Unrealized foreign currency gain (loss), net
1,017

 
(7,863
)
Share-based compensation
6,851

 
8,006

Other non-cash items
(1,208
)
 
3,669

Changes in operating assets and liabilities:
 
 
 

Accounts receivable, net of allowances
(9,068
)
 
(15,762
)
Inventories
12,435

 
3,750

Prepaid expenses and other assets
12,997

 
(7,559
)
Accounts payable, accrued expenses and other liabilities
(1,909
)
 
(4,510
)
Cash provided by operating activities
80,415

 
29,354

Cash flows from investing activities:
 

 
 

Cash paid for purchases of property and equipment
(6,553
)
 
(12,651
)
Proceeds from disposal of property and equipment
1,562

 
2,425

Cash paid for intangible assets
(7,710
)
 
(5,598
)
Change in restricted cash
383

 
953

Cash used in investing activities
(12,318
)
 
(14,871
)
Cash flows from financing activities:
 

 
 

Proceeds from bank borrowings
5,500

 
29,582

Repayments of bank borrowings and capital lease obligations
(8,222
)
 
(32,378
)
Dividends—Series A preferred stock
(9,000
)
 
(9,000
)
Repurchases of common stock
(25,645
)
 

Other
(233
)
 
(338
)
Cash used in financing activities
(37,600
)
 
(12,134
)
Effect of exchange rate changes on cash
127

 
4,526

Net change in cash and cash equivalents
30,624

 
6,875

Cash and cash equivalents—beginning of period
147,565

 
143,341

Cash and cash equivalents—end of period
$
178,189

 
$
150,216

 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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CROCS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Unless otherwise noted in this report, any description of “we,” “us,” or “our” includes Crocs, Inc. (“Crocs” or the “Company”) and its wholly-owned subsidiaries within our reportable operating segments and corporate operations. The Company is engaged in the design, development, manufacturing, worldwide marketing, and distribution of casual lifestyle footwear and accessories for men, women, and children. We strive to be the global leader in the sale of molded footwear featuring fun, comfort, color, and functionality. Our reportable operating segments include: the Americas, operating in North and South America; Asia Pacific, operating throughout Asia, Australia, New Zealand, Africa, and the Middle East; and Europe, operating throughout Europe and Russia.

The accompanying unaudited condensed consolidated interim financial statements include the Company’s accounts and those of its wholly-owned subsidiaries, and reflect all adjustments which are necessary for a fair statement of the financial position, results of operations, and cash flows for the periods presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Such unaudited interim condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q pursuant to the rules and regulations of the U.S. Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

These unaudited condensed consolidated interim financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2016 (“Annual Report”), and have been prepared on a consistent basis with the accounting policies described in Note 1 of the Notes to the Audited Consolidated Financial Statements included in our Annual Report. Our accounting policies did not change in the nine months ended September 30, 2017, except for the new accounting pronouncements adopted as described in Note 2 — Recent Accounting Pronouncements.

Seasonality of Business

Due to the seasonal nature of our footwear, which is more heavily focused on styles suitable for warmer weather, the Company’s business is typically affected by seasonal trends, with higher wholesale sales in its first and second quarters and higher retail sales in its second and third quarters. In addition, our quarterly results of operations may fluctuate significantly as a result of other factors, including general economic conditions or consumer confidence. Accordingly, the Company’s operating results and cash flows for the three and nine months ended September 30, 2017 are not necessarily indicative of the operating results and cash flows for any other quarter or for the full year.

Transactions with Affiliates

The Company receives services from three subsidiaries of Blackstone Capital Partners VI L.P. (“Blackstone”). Blackstone and certain of its permitted transferees currently beneficially own all the outstanding shares of the Company’s Series A Convertible Preferred Stock, which is convertible into approximately 16.1% of the Company’s common stock as of September 30, 2017. Blackstone also has the right to nominate two representatives to serve on the Company’s Board of Directors (the “Board”).

Certain Blackstone subsidiaries provide various services to the Company, including inventory count, cybersecurity and consulting, and workforce management services. The Company paid $0.1 million and less than $0.1 million for the three months ended September 30, 2017 and 2016, respectively, and $0.6 million and $0.6 million for the nine months ended September 30, 2017 and 2016, respectively, for these services. Expenses related to these services are reported in ‘Selling, general and administrative expenses’ in the condensed consolidated statements of operations.

Research, Design, and Development Expenses

Research, design, and development expenses were $2.3 million and $3.7 million for the three months ended September 30, 2017 and 2016, respectively, and $7.4 million and $9.3 million for the nine months ended September 30, 2017 and 2016, respectively, and are reported in ‘Selling, general and administrative expenses’ in the condensed consolidated statements of operations.


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Marketing, Advertising, and Promotional Expenses

Advertising production and promotion costs are expensed when the advertising is first run. Advertising communication costs are expensed in the periods that the communications occur. Certain of the Company’s promotional expenses result from payments under endorsement contracts. Payments under endorsement contracts are expensed on a straight-line basis over the related annual contract terms.

Total marketing expenses inclusive of advertising, production, promotional, and agency expenses reported in ‘Selling, general and administrative expenses’ were:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Advertising, production, promotional, and agency expenses
$
9,946

 
$
11,066

 
$
49,614

 
$
48,664


Prepaid advertising and promotional endorsement costs of $7.3 million and $4.5 million are included in ‘Prepaid expenses and other assets’ in the condensed consolidated balance sheets at September 30, 2017 and December 31, 2016, respectively.

Depreciation and Amortization Expense

Depreciation and amortization expense related to property and equipment and amortization expense related to definite-lived intangible assets, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses,’ respectively, were:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Property and equipment:
 
 
 
 
 
 
 
  Selling, general and administrative expenses
$
2,945

 
$
3,179

 
$
9,287

 
$
9,987

  Cost of sales
554

 
420

 
1,677

 
1,226

  Total depreciation and amortization expense
3,499

 
3,599

 
10,964

 
11,213

Intangibles:
 
 
 
 
 
 
 
  Selling, general and administrative expenses
3,304

 
3,637

 
10,251

 
10,385

  Cost of sales
1,083

 
1,206

 
3,486

 
3,875

    Total amortization expense
4,387

 
4,843

 
13,737

 
14,260

Total depreciation and amortization expense
$
7,886

 
$
8,442

 
$
24,701

 
$
25,473

 
2. RECENT ACCOUNTING PRONOUNCEMENTS
 
New Accounting Pronouncement Adopted
 
Inventory Measurement

In July 2015, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance to measure in-scope inventory at the lower of cost or net realizable value. The Company adopted this guidance on January 1, 2017 on a prospective basis. The adoption did not have a significant effect on our consolidated financial position or results of operations.

New Accounting Pronouncements Not Yet Adopted

Stock Compensation Scope of Modification Accounting

In May 2017, the FASB issued authoritative guidance intended to clarify those changes to terms and conditions of stock-based compensation awards that are required to be accounted for as modifications of existing stock-based awards. This guidance is to be applied prospectively and becomes effective for annual reporting periods beginning after December 15, 2017, including interim

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periods within those periods, with early adoption permitted during any interim period. The Company does not expect this standard will have a material impact on the Company’s consolidated financial statements.

Clarifying the Definition of a Business

In January 2017, the FASB issued authoritative guidance intended to clarify the definition of a business, for purposes of determining whether a business has been acquired or sold, and consequently whether transactions should be accounted for as acquisitions or disposals of a business or as acquisitions or disposals of assets. This guidance is to be applied prospectively and becomes effective for annual reporting periods beginning after December 15, 2017, including interim periods within those periods. The Company does not expect this standard to have a material impact on its consolidated financial statements.

Statement of Cash Flows - Classification and Change in Cash

In August 2016, the FASB issued authoritative guidance intended to clarify how entities should classify certain cash receipts and cash payments on the statement of cash flows. Further, in November 2016, the FASB issued guidance requiring that restricted cash be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. These updates are effective for annual reporting periods beginning after December 15, 2017, and interim periods within those annual periods, with early adoption permitted. The guidance should be applied retrospectively unless it is impractical to do so; in which case, the guidance should be applied prospectively as of the earliest date practicable. The Company does not expect this standard to have a material impact on its consolidated financial statements.

Prepaid Stored-Value Products

In March 2016, the FASB issued guidance related to the recognition of breakage for certain prepaid stored-value products. This update aligns recognition of the financial liabilities related to prepaid stored-value products (for example, prepaid gift cards), with Topic 606, Revenue from Contracts with Customers, for non-financial liabilities. In general, certain of these liabilities may be extinguished proportionally in earnings as redemptions occur, or when redemption is remote if issuers are not entitled to the unredeemed stored value. This standard is effective for annual periods (including interim periods) beginning after December 15, 2017, with early adoption permitted. The Company has elected the modified retrospective method of adoption. The Company does not expect this standard to have a material impact on its consolidated financial statements.

Leases

In February 2016, the FASB issued authoritative guidance intended to increase transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet and disclosing key information about leasing arrangements. Under the new guidance, lessees will be required to recognize a right-of-use asset and a lease liability, measured on a discounted basis, at the commencement date for all leases with terms greater than twelve months. Additionally, this guidance will require disclosures to help investors and other financial statement users to better understand the amount, timing, and uncertainty of cash flows arising from leases, including qualitative and quantitative requirements. The guidance should be applied under a modified retrospective transition approach for leases existing at the beginning of the earliest comparative period presented in the adoption-period financial statements. Any leases that expire before the initial application date will not require any accounting adjustment. This guidance is effective for annual reporting periods beginning after December 15, 2018, including interim periods within those annual periods, with early adoption permitted.

The Company will adopt this guidance beginning with the quarterly reporting period ending March 31, 2019. In July 2017, the Company established an implementation team and engaged external advisers to develop a multi-phase plan to assess the Company’s leasing arrangements, as well as any changes to accounting policies, processes or systems necessary to adopt the requirements of the new standard. The Company is evaluating the full impact this guidance will have on its consolidated financial statements, and expects that adoption will result in significant increases in lease-related assets and liabilities on its consolidated balance sheet.

Revenue Recognition

In May 2014, the FASB issued authoritative guidance related to new accounting requirements for the recognition of revenue from contracts with customers. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for the goods or services. Subsequent to the release of this guidance, the FASB has issued additional updates intended to provide interpretive clarifications and to reduce the cost and complexity of applying the new revenue recognition standard both at transition and on an ongoing basis. The new standard and related amendments are effective for annual reporting periods beginning

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after December 15, 2017, and interim periods within those annual periods. Upon adoption of the new standard, the use of either a full retrospective or modified retrospective transition method is permitted.

In December 2016, the Company established an implementation team and engaged external advisers to develop a multi-phase plan to assess the Company’s business and contracts, as well as any changes to accounting policies, processes or systems necessary to adopt the requirements of the new standard. The Company has elected the modified retrospective method of adoption. The Company has completed a review of its revenue contracts and terms and is finalizing its assessment regarding the effects of adoption of the new standard on its consolidated financial statements and disclosures. Concurrent with adoption, the Company will change its presentation of product returns in the condensed consolidated balance sheets by reporting an asset for the right to receive returned product and a return liability. In addition, customer payments received in advance of delivery will be reported as a contract liability in the Company’s condensed consolidated balance sheets. The Company is continuing its evaluation of the impact of any additional accounting and disclosure changes on its business processes, controls and systems. The Company will provide additional information regarding expected effects on its consolidated financial statements and disclosures in its next annual report.

Other Pronouncements

Other new pronouncements issued but not effective until after September 30, 2017 are not expected to have a material impact on the Company’s consolidated financial statements.

3. INVENTORIES
 
The following table summarizes inventories by major classification: 
 
September 30,
2017
 
December 31,
2016
 
(in thousands)
Finished goods
$
136,665

 
$
142,333

Raw materials
2,772

 
4,042

Work-in-progress
845

 
654

Total inventories
$
140,282

 
$
147,029


4. INTANGIBLE ASSETS, NET

‘Intangible assets, net’ reported in the condensed consolidated balance sheets consist of the following:
 
 
 
September 30, 2017
 
December 31, 2016
 
Useful Life
 
Gross
 
Accum. Amortiz.
 
Net
 
Gross
 
Accum. Amortiz.
 
Net
 
(in years)
 
(in thousands)
Intangible assets subject to amortization:
 
 
 
 
 
 
 
 
 
 
 
 
 
  Capitalized software
2 - 7
 
$
145,247

 
$
(87,948
)
 
$
57,299

 
$
142,358

 
$
(74,530
)
 
$
67,828

Patents, copyrights, and trademarks
6 - 25
 
6,498

 
(5,700
)
 
798

 
6,438

 
(5,471
)
 
967

Other
 
 
2,243

 
(2,243
)
 

 
2,855

 
(2,855
)
 

Intangible assets not subject to amortization:
 
 
 
 
 
 
 
 
 
 
 
 
 
  In progress (1)
 
 
8,086

 

 
8,086

 
3,616

 

 
3,616

  Trademarks and other
 
 
322

 

 
322

 
289

 

 
289

  Total
 
 
$
162,396

 
$
(95,891
)
 
$
66,505

 
$
155,556

 
$
(82,856
)
 
$
72,700

(1) Primarily consists of capitalized software project costs under development.


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Estimated future annual amortization expense of intangible assets is:
 
 
September 30, 2017


 
(in thousands)
2017 (remainder of year)
 
$
4,404

2018
 
16,284

2019
 
14,005

2020
 
11,309

2021
 
10,944

Thereafter
 
1,151

Total
 
$
58,097


5. ACCRUED EXPENSES AND OTHER LIABILITIES
 
The following table summarizes accrued expenses and other liabilities: 
 
September 30,
2017
 
December 31,
2016
 
(in thousands)
Accrued compensation and benefits
$
31,010

 
$
20,898

Fulfillment, freight, and duties (1)
11,784

 
14,572

Professional services
11,578

 
10,900

Sales/use and value added taxes payable
5,027

 
4,978

Accrued rent and occupancy
6,551

 
7,335

Royalties payable and deferred revenue
6,758

 
7,475

Other (2)
12,128

 
12,124

Total accrued expenses and other liabilities
$
84,836

 
$
78,282

(1) Includes customs duty legal accrual liability at December 31, 2016, which was settled in April 2017.
(2) Includes current liabilities related to Series A preferred stock dividends at September 30, 2017 and December 31, 2016. Other accrued liabilities at December 31, 2016 also includes net derivative liabilities.

6. FAIR VALUE MEASUREMENTS
 
Recurring Fair Value Measurements
 
U.S. GAAP for fair value establishes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques (market approach, income approach, and cost approach). The Company utilizes a combination of market and income approaches to value derivative instruments. The Company’s financial assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. The three levels of the hierarchy and the related inputs are as follows:
Level
 
Inputs
 
 
 
1
 
Unadjusted quoted prices in active markets for identical assets and liabilities.
2
 
Unadjusted quoted prices in active markets for similar assets and liabilities;
 
 
Unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active; or
 
 
Inputs other than quoted prices that are observable for the asset or liability.
3
 
Unobservable inputs for the asset or liability.

The financial assets and liabilities that are measured and recorded at fair value on a recurring basis consist of the Company’s derivative instruments. The Company’s derivative instruments are foreign currency forward exchange contracts. The Company manages credit risk of its derivative instruments on the basis of its net exposure with its counterparty and has elected to measure the fair value in the same manner. All of the Company’s derivative instruments are classified as Level 2 and are reported in the condensed consolidated balance sheets within ‘Prepaid expenses and other assets’ at September 30, 2017, and ‘Accrued expenses and other liabilities’ at December 31, 2016. There were no transfers between Level 1 or Level 2, nor were there any outstanding

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derivative instruments classified as Level 3 as of September 30, 2017 or December 31, 2016. The fair value of the Company’s derivative instruments was an asset of $0.3 million and a liability of $0.2 million at September 30, 2017 and December 31, 2016, respectively. See Note 7 — Derivative Financial Instruments for more information.

The carrying amounts of the Company’s cash and cash equivalents, accounts receivable, accounts payable, and current accrued expenses and other liabilities approximate their fair value as recorded due to the short-term maturity of these instruments.

The Company’s borrowing instruments are recorded at their carrying values in the condensed consolidated balance sheets, which may differ from their respective fair values. The fair values of the Company’s outstanding notes payable approximate their carrying values at September 30, 2017 and December 31, 2016, based on interest rates currently available to the Company for similar borrowings.
 
September 30, 2017
 
December 31, 2016
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
 
(in thousands)
Borrowings and capital lease obligations
$
1,105

 
$
1,105

 
$
2,378

 
$
2,378

Non-Financial Assets and Liabilities
The Company’s non-financial assets, which primarily consist of property and equipment, goodwill, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. However, on a periodic basis or whenever events or changes in circumstances indicate that their carrying value may not be fully recoverable (and at least annually for goodwill and indefinite-lived intangible assets), non-financial instruments are assessed for impairment and, if applicable, written down to and recorded at fair value.

Impairment is reported in ‘Selling, general and administrative expenses’ in the Company’s condensed consolidated statements of operations. The fair values of these assets were determined based on Level 3 measurements, including estimates of the amount and timing of future cash flows based upon historical experience, expected market conditions, and management’s plans. During the three and nine month periods ended September 30, 2017 and 2016, the Company recorded non-cash impairment to reduce the carrying values of certain retail store assets to their estimated fair value, as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Retail store asset impairment
$
150

 
$
930

 
$
150

 
$
1,695


7. DERIVATIVE FINANCIAL INSTRUMENTS
 
The Company transacts business in various foreign countries and is therefore exposed to foreign currency exchange rate risk that impacts the reported U.S. Dollar amounts of revenues, costs, and certain foreign currency monetary assets and liabilities. In order to manage exposure to fluctuations in foreign currency and to reduce the volatility in earnings caused by fluctuations in foreign exchange rates, the Company enters into forward contracts to buy and sell foreign currency. By policy, the Company does not enter into these contracts for trading purposes or speculation.

Counterparty default risk is considered low because the forward contracts that the Company enters into are over-the-counter instruments transacted with highly-rated financial institutions. The Company was not required to and did not post collateral as of September 30, 2017 or December 31, 2016.

The Company’s derivative instruments are recorded at fair value as a derivative asset or liability in the condensed consolidated balance sheets. The Company reports derivative instruments with the same counterparty on a net basis when a master netting arrangement is in place. Changes in fair value are recognized within ‘Foreign currency gain (loss), net’ in the condensed consolidated statements of operations. For the condensed consolidated statements of cash flows, the Company classifies cash flows from derivative instruments at settlement in the same category as the cash flows from the related hedged items within ‘Cash provided by operating activities.’

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Results of Derivative Activities

The fair values of derivative assets and liabilities, net, all of which are classified as Level 2, are reported within either ‘Prepaid expenses and other assets’ or ‘Accrued expenses and other liabilities’ in the condensed consolidated balance sheets were:
 
September 30, 2017
 
December 31, 2016
 
Derivative Assets
 
Derivative Liabilities
 
Derivative Assets
 
Derivative Liabilities
 
(in thousands)
Foreign currency transaction gains (losses)

$
1,118

 
$
(833
)
 
$
6,541

 
$
(6,698
)
Netting of counterparty contracts
(833
)
 
833

 
(6,541
)
 
6,541

  Foreign currency forward contract derivatives
$
285

 
$

 
$

 
$
(157
)

The notional amounts of outstanding foreign currency forward exchange contracts shown below report the total U.S. Dollar equivalent position and the net contract fair values for each foreign currency position.
 
September 30, 2017
 
December 31, 2016
 
Notional
 
Fair Value
 
Notional
 
Fair Value
 
(in thousands)
Euro
$
41,271

 
$
(159
)
 
$
71,228

 
$
(1,441
)
Japanese Yen
36,616

 
(25
)
 
87,171

 
4,180

Singapore Dollar
31,689

 
245

 
94,763

 
(2,611
)
South Korean Won
26,380

 
98

 
8,278

 
407

British Pound Sterling
6,195

 
73

 
14,332

 
(660
)
Other currencies
50,218

 
53

 
52,449

 
(32
)
Total
$
192,369

 
$
285

 
$
328,221

 
$
(157
)
 
 
 
 
 
 
 
 
Latest maturity date
October 2017
 
 
January 2017
 

Amounts reported in ‘Foreign currency gain (loss), net’ in the condensed consolidated statements of operations include both realized and unrealized gains (losses) from foreign currency transactions and derivative contracts and were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Foreign currency transaction gains (losses)
$
(674
)
 
$
3,039

 
$
1,120

 
$
11,804

Foreign currency forward exchange contracts gains
 
 
 
 
 
 
 
(losses)
417

 
(1,660
)
 
(939
)
 
(13,372
)
Foreign currency gain (loss), net
$
(257
)
 
$
1,379

 
$
181

 
$
(1,568
)

8. REVOLVING CREDIT FACILITY AND BANK BORROWINGS
 
The Company’s borrowings consist of:
 
September 30,
2017
 
December 31,
2016
 
(in thousands)
Notes payable
$
1,058

 
$
2,329

Capital lease obligations
47

 
49

Total borrowings and capital lease obligations
1,105

 
2,378

Less: Current portion of borrowings and capital lease obligations
1,070

 
2,338

Total long-term capital lease obligations
$
35

 
$
40



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Senior Revolving Credit Facility

In December 2011, the Company entered into a revolving credit facility (“the Facility”), pursuant to an Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), with the lenders named therein and PNC Bank, National Association (“PNC”), as a lender and administrative agent for the lenders. The Credit Agreement, as amended, contains certain covenants that restrict certain actions by the Company, including limitations on: (i) stock repurchases to $50.0 million per year, subject to certain restrictions; and (ii) capital expenditures and commitments to $50.0 million per year. The Credit Agreement also requires the Company to meet certain financial covenant ratios that become effective when average outstanding borrowings under the Credit Agreement, including letters of credit, exceed $20.0 million during certain periods or if the outstanding borrowings exceed the borrowing base. If the financial covenant ratios are in effect, the Company must maintain a minimum fixed charge coverage ratio of 1.10 to 1.00, and a maximum leverage ratio of 2.00 to 1.00. As of September 30, 2017, the Company was in compliance with all financial covenants.
As of September 30, 2017, the total commitments available from the lenders under the Facility were $80.0 million. At September 30, 2017, the Company had no outstanding borrowings and $1.3 million in outstanding letters of credit under the Facility, which reduce the amounts available for borrowing under the terms of the Facility. As of September 30, 2017 and December 31, 2016, the Company had $78.7 million of available borrowing capacity under the Facility.
On October 13, 2017, the Company entered into the Fourteenth Amendment to the Amended and Restated Credit Agreement which: (i) increased the total commitments under the Facility to $100.0 million from $80.0 million, (ii) added an additional lender under the Facility, (iii) increased the amount of average outstanding borrowings at which financial covenant ratios become effective during certain periods to the lesser of $40.0 million or 40% of the total commitments, (iv) permits certain intercompany loans of up to $375.0 million, and (v) amended certain other provisions to be more favorable to the Company.
Asia Revolving Credit Facility
The Company’s revolving credit facility agreement (the “Asia Facility”) with HSBC Bank (China) Company Limited, Shanghai Branch (“HSBC”), provides the Company uncommitted dual currency revolving loan facilities of up to 40.0 million Chinese Renminbi (“RMB”), or $6.0 million, with a combined facility limit of RMB 60.0 million, or $9.0 million. As of September 30, 2017 and December 31, 2016, borrowings under the Asia Facility remained suspended at the discretion of HSBC. The Asia Facility will mature in February 2021.
Notes Payable
Notes payable incur interest at fixed rates ranging from 1.95% to 2.83%.

The maturities of the Company’s debt and capital lease obligations were:
 
September 30, 2017
 
(in thousands)
2017 (remainder of year)
$
1,065

2018
13

2019
13

2020
11

2021
3

Total principal debt maturities and capital lease obligations
1,105

Less: current portion
1,070

Non-current portion
$
35


9. EQUITY

Common Stock

The Company has one class of common stock with a par value of $0.001 per share. There are 250 million shares of common stock authorized for issuance. Holders of common stock are entitled to one vote per share on all matters presented to the stockholders.


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Common Stock Repurchase Program
For the three and nine months ended September 30, 2017, the Company repurchased 2.1 million and 3.4 million shares of its common stock, respectively, at a cost of $17.1 million and $27.1 million, including commissions, respectively, including unsettled trades for 150,000 shares totaling $1.4 million, which were completed on October 2, 2017. During the three and nine months ended September 30, 2016, the Company did not repurchase any of its common stock. As of September 30, 2017, the Company had remaining authorization to repurchase approximately $91.7 million of its common stock, subject to restrictions under its Credit Agreement. See Part II - Other Information, Item 2. ‘Unregistered Sales of Equity Securities’ for further details on repurchases of common stock during the three months ended September 30, 2017.

Preferred Stock

The Company has authorized and available for issuance 4.0 million shares of preferred stock. None of these preferred shares are issued or outstanding.

Series A Convertible Preferred Stock

The Company is authorized to issue up to 1.0 million shares of Series A Convertible Preferred Stock (“Series A Preferred Stock”), par value $0.001 per share, of which 0.2 million shares were issued to Blackstone and certain of its permitted transferees in January 2014. The Series A Preferred Stock has a stated value of $1,000 per share.
Participation Rights and Dividends
Holders of the Series A Preferred Stock are entitled to receive dividends declared or paid on the Company’s common stock and are entitled to vote together with the holders of the Company’s common stock as a single class, in each case, on an as-converted basis. Holders of the Series A Preferred Stock also have certain limited special approval rights, including with respect to the issuance of pari passu or senior equity securities of the Company.
The Series A Preferred Stock ranks senior to the Company’s common stock with respect to rights to preferred dividends, liquidation, winding-up, and dissolution. Holders of Series A Preferred Stock are entitled to cumulative dividends payable quarterly in cash at a rate of 6% per annum. If the Company fails to make timely dividend payments, the dividend rate will increase to 8% per annum until such time as all accrued but unpaid dividends have been paid in full. As of September 30, 2017 and December 31, 2016, the Company had accrued preferred dividends of $3.0 million, which are reported in ‘Accrued expenses and other liabilities’ in the condensed consolidated balance sheets. These accrued dividends were paid in cash in October 2017 and January 2017, respectively.
Conversion Rights of the Company and Blackstone
The Series A Preferred Stock is convertible at the option of the holders at any time into shares of common stock at a conversion price of $14.50 per share, subject to adjustment for customary anti-dilution provisions. Beginning January 27, 2017, provided the closing price of the Company’s common stock has been equal to or greater than $29.00 for 20 consecutive trading days, the Company may elect to convert all or a portion of the Series A Preferred Stock into an equivalent number of shares of common stock. At September 30, 2017, had the holders converted or the Company been entitled to exercise its conversion right, the Series A Preferred Stock would have been convertible into 13,793,100 shares of common stock.
Redemption Rights of the Company and Blackstone
The Company has the option to redeem the Series A Preferred Stock anytime on or after January 27, 2022, for 100% of the stated redemption value of $200 million plus all accrued and unpaid dividends.
Blackstone has the option to cause the redemption of the Series A Preferred Stock any time after January 27, 2022, or upon a change in control. Further, upon certain change of control events, Blackstone can require the Company to repurchase the Series A Preferred Stock at 101% of the redemption value plus all accrued and unpaid dividends. The carrying value of the Series A Preferred Stock is accreted up to its $200 million redemption value on a straight-line basis through the redemption date.

10. SHARE-BASED COMPENSATION
The Company’s share-based compensation awards are issued under the 2015 Equity Incentive Plan (“2015 Plan”) and two predecessor plans, the 2005 Equity Incentive Plan and the 2007 Equity Incentive Plan (the “2007 Plan”). Any awards that expire or are forfeited under the 2007 Plan become available for issuance under the 2015 Plan. There were 7,928,141 shares of common

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stock reserved and authorized for issuance at September 30, 2017, under all plans, subject to adjustment for future stock splits, stock dividends, and similar changes in capitalization.
Refer to Notes 1 and 11 of the Company’s Annual Report for a detailed description of the Company’s share-based compensation awards, including information related to grant date fair value, vesting terms, performance, and other conditions.
Share-Based Compensation Expense
Pre-tax share-based compensation expense reported in the Company’s condensed consolidated statements of operations was as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Cost of sales
$
93

 
$
135

 
$
293

 
$
386

Selling, general and administrative expenses
2,813

 
1,973

 
6,558

 
7,620

Total share-based compensation expense
$
2,906

 
$
2,108

 
$
6,851

 
$
8,006


Stock Option Activity

Stock option activity during the nine months ended September 30, 2017 was:
 
Number of Options
Outstanding December 31, 2016
518,252

Granted
200,000

Exercised
(1,500
)
Forfeited or expired
(156,720
)
Outstanding September 30, 2017
560,032


As of September 30, 2017, the Company had $0.5 million of total unrecognized share-based compensation expense related to unvested options, which is expected to be amortized over the remaining weighted average period of 2.51 years. The weighted average exercise price of vested options was $12.98 per share.

Restricted Stock Awards and Restricted Stock Units Activity

The Company grants time-based Restricted Stock Awards (“RSAs”) as well as time-based and performance-based Restricted Stock Units (“RSUs”). RSA and RSU activity during the nine months ended September 30, 2017 was:
 
Restricted Stock Awards
 
Restricted Stock Units
 
Shares
 
Weighted Average Grant Date Fair Value
 
Shares
 
Weighted Average Grant Date Fair Value
Unvested at December 31, 2016
11,430

 
$
10.28

 
3,855,368

 
$
10.31

Granted
35,114

 
6.84

 
2,433,601

 
6.84

Vested
(20,208
)
 
8.78

 
(717,302
)
 
10.90

Forfeited

 

 
(1,720,629
)
 
9.61

Unvested at September 30, 2017
26,336

 
$
6.84

 
3,851,038

 
$
8.00


RSAs vested during the nine months ended September 30, 2017 consisted entirely of time-based awards. As of September 30, 2017, unrecognized share-based compensation expense for RSAs was $0.2 million, which is expected to amortize over a remaining weighted average period of 0.68 years.
RSUs vested during the nine months ended September 30, 2017 consisted of 648,985 time-based awards and 68,317 performance-based awards. As of September 30, 2017, unrecognized share-based compensation expenses for time-based and performance-

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based awards were $11.6 million and $4.7 million, respectively, and are expected to amortize over a remaining weighted average period of 1.98 years.

11. INCOME TAXES

Income tax expense and effective tax rates were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands, except effective tax rate)
Income before income taxes
$
2,584

 
$
157

 
$
48,118

 
$
31,854

Income tax expense
955

 
1,690

 
13,519

 
7,704

Effective tax rate
37.0
%
 
1,076.4
%
 
28.1
%
 
24.2
%

The decrease in the effective tax rate for the three months ended September 30, 2017, compared to the same period in 2016, is primarily due to the atypical rate in 2016 caused by the amount of income tax expense compared to the low income before income taxes for the period. Additionally, there is an impact due to operating losses in certain jurisdictions where the Company has determined that it is not more likely than not to realize the associated tax benefits, partially offset by tax expense recorded in profitable jurisdictions. The increase in effective tax rate for the nine months ended September 30, 2017, compared to the same period in 2016, was driven primarily by tax expense recorded in profitable jurisdictions, partially offset by operating losses in certain jurisdictions where the Company has determined that it is not more likely than not to realize the associated tax benefits. The Company’s effective income tax rate, for each period presented, also differs from the federal U.S. statutory rate primarily due to differences in income tax rates between U.S. and foreign jurisdictions as well as book losses in certain jurisdictions for which tax benefits cannot be recognized. There were no significant or unusual discrete tax items during the three and nine months ended September 30, 2017. The Company had unrecognized tax benefits of $5.1 million and $4.8 million at September 30, 2017 and December 31, 2016, respectively, and the Company does not expect any significant changes in tax benefits in the next twelve months.

12. EARNINGS PER SHARE
 
Basic and diluted earnings per common share (“EPS”) for the three and nine months ended September 30, 2017 and 2016 were as follows: 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Numerator:
 

 
 

 
 
 
 
Net income (loss) attributable to common
 
 
 
 
 
 
 
 stockholders
$
(2,263
)
 
$
(5,352
)
 
$
22,978

 
$
12,744

Less: adjustment for income allocated to participating
 
 
 
 
 
 
 
securities

 

 
(3,642
)
 
(2,018
)
Net income (loss) attributable to common
 
 
 
 
 
 
 
stockholders - basic and diluted
$
(2,263
)
 
$
(5,352
)
 
$
19,336

 
$
10,726

Denominator:
 

 
 

 
 
 
 
Weighted average common shares outstanding - basic
71,895

 
73,493

 
73,212

 
73,323

Plus: dilutive effect of stock options and unvested
 
 
 
 
 
 
 
restricted stock units

 

 
948

 
1,407

Weighted average common shares outstanding -
 
 
 
 
 
 
 
diluted
71,895

 
73,493

 
74,160

 
74,730

 
 
 
 
 
 
 
 
Net income (loss) per common share:
 

 
 

 
 
 
 
Basic
$
(0.03
)
 
$
(0.07
)
 
$
0.26

 
$
0.15

Diluted
$
(0.03
)
 
$
(0.07
)
 
$
0.26

 
$
0.14


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Diluted EPS is calculated using the two-class method. For the three months ended September 30, 2016, 1.7 million options and restricted stock units were excluded from the calculation of diluted EPS under the two-class method because the effect was anti-dilutive. For the nine months ended September 30, 2017, 0.7 million stock options and RSUs, and all potentially convertible Series A Preferred Stock shares were excluded from the calculation of diluted EPS under the two-class method because the effect would be anti-dilutive. If converted, Series A Preferred Stock would represent approximately 16.1% of the Company’s common stock outstanding, or 13.8 million additional common shares as of September 30, 2017.

13. COMMITMENTS AND CONTINGENCIES
 
Rental Commitments and Contingencies
The Company rents retail store, office and warehouse space, vehicles, and equipment under operating leases expiring at various dates through 2033. Rent expense for leases with escalations or rent holidays is recognized on a straight-line basis over the lease term beginning on the lease inception date. Certain leases also provide for contingent rents, which are generally determined as a percent of sales in excess of specified levels. A contingent rent liability is recognized together with the corresponding rent expense when specified levels have been achieved or when the Company determines that achieving the specified levels during the period is probable.
Future minimum lease payments under operating leases were as follows:

September 30, 2017
 
(in thousands)
2017 (remainder of year)
$
14,992

2018
51,789

2019
36,534

2020
28,287

2021
22,514

Thereafter
68,658

     Total minimum lease payments
$
222,774

Minimum sublease rental income of $0.2 million under non-cancelable subleases, and contingent rentals, which may be paid under certain retail leases on a basis of percentage of sales in excess of stipulated amounts, are excluded from the commitment schedule.

Rent expense under operating leases are as follows: 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Minimum rentals (1)
$
19,505

 
$
21,983

 
$
60,693

 
$
66,967

Contingent rentals
4,264

 
4,789

 
12,086

 
12,467

Less: Sublease rentals
(55
)
 
(21
)
 
(144
)
 
(139
)
Total rent expense
$
23,714

 
$
26,751

 
$
72,635

 
$
79,295

(1) Minimum rentals include all lease payments as well as fixed and variable common area maintenance, parking, and storage fees, which were approximately $2.5 million and $2.5 million during the three months ended September 30, 2017 and 2016, respectively, and $7.7 million during each of the nine months ended September 30, 2017 and 2016, respectively.

Purchase Commitments
Under the terms of an annual supply agreement, the Company guarantees payment for certain third-party manufacturer purchases of raw materials used in the manufacture of its products, up to a maximum of €3.5 million (approximately $4.1 million as of September 30, 2017).
As of September 30, 2017, the Company had purchase commitments with other third-party manufacturers, primarily for materials and supplies used in the manufacture of the Company’s products, for an aggregate of $114.9 million. The Company also renewed agreements with two service providers, for three years at $5.0 million per year, and 18 months at $2.0 million per year, respectively.

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Government Tax Audits
The Company is regularly subject to, and is currently undergoing, audits by various tax authorities in the United States and several foreign jurisdictions, including customs duties, import and other taxes for prior tax years. See Note 15 — Legal Proceedings for additional information.
Other
During its normal course of business, the Company may make certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain matters. The Company cannot determine a range of estimated future payments and has not recorded any liability for indemnities, commitments and guarantees in the accompanying condensed consolidated balance sheets.
See Note 15 — Legal Proceedings for further details regarding potential loss contingencies related to government tax audits and other current legal proceedings.


17

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14. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION

The Company has three reportable operating segments based on the geographic nature of its operations: the Americas, Asia Pacific, and Europe. In addition, the ‘Other businesses’ category aggregates insignificant operating segments that do not meet the reportable segment threshold, including manufacturing operations located in Mexico and Italy, and corporate operations.

Each of the reportable operating segments derives its revenues from the sale of footwear and accessories to external customers. Revenues for ‘Other businesses’ include non-footwear product sales to external customers that are excluded from the measurement of segment operating revenues and income.

Segment performance is evaluated based on segment results without allocating corporate expenses, or indirect general, administrative, and other expenses. Segment profits or losses include adjustments to eliminate inter-segment sales. Reconciling items between segment operating income and income (loss) from operations consist of other businesses and unallocated corporate and other expenses, as well as inter-segment eliminations. The following tables set forth information related to reportable operating segments:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Revenues: (1)
 
 
 
 
 
 
 
Americas
$
120,459

 
$
114,659

 
$
374,336

 
$
373,886

Asia Pacific
80,039

 
90,920

 
303,028

 
326,268

Europe
42,521

 
40,038

 
146,492

 
148,035

Total segment revenues
243,019

 
245,617

 
823,856

 
848,189

Other businesses
254

 
271

 
545

 
667

Total consolidated revenues
$
243,273

 
$
245,888

 
$
824,401

 
$
848,856

Operating income: (1)
 
 
 
 
 
 
 
Americas
$
24,102

 
$
16,329

 
$
71,309

 
$
50,919

Asia Pacific
13,264

 
17,303

 
73,294

 
77,687

Europe
5,416

 
1,751

 
27,721

 
16,712

Total segment income from operations
42,782

 
35,383

 
172,324

 
145,318

Reconciliation of total segment income (loss) from
 

 
 

 
 
 
 
operations to income before income taxes:
 
 
 
 
 
 
 
Other businesses
(6,233
)
 
(7,179
)
 
(16,883
)
 
(19,291
)
Unallocated corporate and other
(33,864
)
 
(29,419
)
 
(107,728
)
 
(92,394
)
Income (loss) from operations
2,685

 
(1,215
)
 
47,713

 
33,633

Foreign currency gain (loss), net
(257
)
 
1,379

 
181

 
(1,568
)
Interest income
269

 
178

 
576

 
558

Interest expense
(167
)
 
(184
)
 
(539
)
 
(661
)
Other income (loss)
54

 
(1
)
 
187

 
(108
)
Income before income taxes
$
2,584

 
$
157

 
$
48,118

 
$
31,854

Depreciation and amortization:
 
 
 
 
 
 
 
Americas
$
1,383

 
$
1,417

 
$
4,075

 
$
4,400

Asia Pacific
863

 
1,036

 
2,710

 
3,107

Europe
374

 
319

 
1,138

 
1,815

Total segment depreciation and amortization
2,620

 
2,772

 
7,923

 
9,322

Other businesses
1,618

 
1,614

 
5,106

 
5,060

Unallocated corporate and other
3,648

 
4,056

 
11,672

 
11,091

Total consolidated depreciation and amortization
$
7,886

 
$
8,442

 
$
24,701

 
$
25,473

(1) Revenues and operating results reflect targeted reductions of company-operated stores and discount channel sales, a focus on higher margin core molded products, and continued focus on reducing selling, general and administrative expenses.

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15. LEGAL PROCEEDINGS

The Company was subjected to an audit by the Brazilian Federal Tax Authorities related to imports of footwear from China between 2010 and 2014. On January 13, 2015, the Company was notified about the issuance of assessments totaling approximately $4.6 million, plus interest and penalties, for the period January 2010 through May 2011. The Company has disputed these assessments and asserted defenses to the claims. On February 25, 2015, the Company received additional assessments totaling approximately $10.5 million, plus interest and penalties, related to the remainder of the audit period. The Company has also disputed these assessments and asserted defenses to these claims in administrative appeals. On August 29, 2017, the Company received a favorable ruling on its appeal of the first assessment, which the Company expects the taxing authority to appeal. The remaining assessments are still pending appeal. In the event that the definitive resolution of these administrative appeals is adverse to the Company, the Company has recourse to further judicial processes, which would likely require the posting of a bond. The Company has not recorded these items within the condensed consolidated financial statements as it is not possible at this time to predict the timing or outcome of this matter or to estimate a potential amount of loss, if any.

The Company was subjected to an audit by U.S. Customs & Border Protection ("CBP") in respect of the period from 2006 to 2010. In October 2013, CBP issued their final audit report. In that report CBP projected that unpaid duties totaling approximately $12.4 million were due for the period under review and recommended collection of the duties due. On April 20, 2017, CBP agreed to settle the matter and accepted the Company’s previously tendered payment of $7 million. This matter is now closed. The settlement was reported in the Company’s condensed financial statements as of March 31, 2017.

For all other claims and other disputes, the Company has accrued estimated losses of $0.5 million within ‘Accrued expenses and other liabilities’ in its condensed consolidated balance sheet as of September 30, 2017. Where the Company is able to estimate possible losses or a range of possible losses, the Company estimates that as of September 30, 2017, it is reasonably possible that losses associated with these claims and other disputes could potentially exceed amounts accrued by the Company by up to $0.1 million.
The Company is subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims. The Company is not party to any other pending legal proceedings that it believes would reasonably have a material adverse impact on its business, financial position, results of operations, or cash flows.

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Business Overview
 
Crocs, Inc. and its consolidated subsidiaries (collectively, the “Company,” “Crocs,” “we,” “our,” or “us”) are engaged in the design, development, manufacturing, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for men, women, and children. The broad appeal of our footwear has allowed us to market our products through a wide range of distribution channels, our own Crocs single-branded stores including both full-price and outlet stores, our own e-commerce sites, traditional multi-branded stores including family footwear stores, sporting goods stores and a variety of specialty and independent retail channels, and third-party e-commerce sites. In select markets we also sell to distributors that are typically granted the rights to distribute our products in a given geographical area.
 
Known or Anticipated Trends

Based on our recent operating results and current perspectives on our operating environment, we anticipate certain trends to impact our operating results:

Continued softening in select global regional economies and a cautious retail environment may negatively affect customer purchasing trends. 

Foreign exchange rate volatility may continue to impact our reported U.S. Dollar results from our foreign operations.

Consumer spending preferences continue to shift toward e-commerce and away from brick and mortar stores. This has resulted in continued sales growth in our e-commerce channel, as well as on various e-tail sites operated by wholesalers, and contributed to declining foot traffic in our retail locations.

We anticipate lower retail revenues and selling, general and administrative expenses (“SG&A”) as we close less productive stores as leases expire and transfer select company-operated stores to distributors. Distributor revenues are reported within our wholesale channel.

We anticipate that our annual gross margin for 2017 will trend to approximately 50%, as our seasonal sales volumes are lower in our third and fourth quarters.

We have identified reductions in SG&A in the amount of $75 to $85 million which are projected to generate an annual $30 to $35 million improvement in earnings before interest and taxes by 2019, compared to 2016. We expect to achieve approximately $30 million of these SG&A reductions in 2017. We expect to incur charges of approximately $10 to $15 million over the next two years to achieve these SG&A reductions, with approximately $10 million of that being incurred in 2017, of which $7.6 million had been incurred through September 30, 2017. We anticipate closing or transferring approximately 95 and 65 company-operated retail stores in 2017 and 2018, respectively, thereby reducing our total store count to approximately 400 from 558 at the end of 2016. The majority of company-operated store closures will occur as store leases expire.

We anticipate lower retail revenues as we continue to optimize our sales channels.

 Use of Non-GAAP Financial Measures
 
In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America (“U.S. GAAP”), we present certain information related to our current period results of operations through “constant currency,” which is a non-GAAP financial measure and should be viewed as a supplement to our results of operations and presentation of reportable segments under U.S. GAAP. Constant currency represents current period results that have been retranslated using prior year average foreign exchange rates for the comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rate fluctuations.
 
Management uses constant currency to assist in comparing business trends from period to period on a consistent basis in communications with the Board of Directors (the “Board”), stockholders, analysts, and investors concerning our financial performance. We believe constant currency is useful to investors and other users of our consolidated financial statements as an additional tool to evaluate operating performance. We believe it also provides a useful baseline for analyzing trends in our operations. Investors should not consider constant currency in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP.

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Financial Highlights
 
The following are significant developments in our businesses during the three months ended September 30, 2017:

Revenues for the three months ended September 30, 2017 were $243.3 million, a decrease of $2.6 million, or 1.1%, compared to the same period in 2016.

Cost of sales for the three months ended September 30, 2017 was $119.8 million, a decrease of $3.6 million, or 3.0%, compared to the same period in 2016.

Gross profit for the three months ended September 30, 2017 was $123.5 million, an increase of $1.0 million, or 0.8%. Gross margin increased 100 basis points to 50.8%, compared to the same period in 2016.

SG&A decreased $2.9 million, or 2.3%, after the effects of $3.6 million in strategic consulting and reorganization costs, for the three months ended September 30, 2017 compared to the same period in 2016.

Income from operations improved by $3.9 million, coming in at $2.7 million compared to last year’s third quarter loss of $1.2 million.

Net loss attributable to common stockholders improved $3.1 million to a loss of $2.3 million compared to a loss of $5.4 million for the same period in 2016. Basic and diluted net loss per common share was $0.03 for the three months ended September 30, 2017, compared to $0.07 for the three months ended September 30, 2016.
 
Future Outlook
 
We intend to continue our strategic plans for long-term improvement and growth of the business, which comprise these key initiatives: 

(1)    focusing on driving clogs and sandals growth (sandals includes flips and slides),

(2)    enhancing brand relevance and esteem through our “Come as You Are” campaign using effective digital marketing,

(3)    focusing on driving consistent growth in e-commerce and wholesale and optimizing distributor and outlet productivity and performance,

(4)    focusing time and investment on driving growth in core markets in Asia and the Americas,

(5)    driving improved profitability through greater cost and working capital efficiency, and

(6)    elevating internal communication and employee engagement.

We believe these initiatives will better position Crocs to adapt to changing customer demands and global economic developments. We are focusing on our core molded footwear heritage by narrowing our product line with an emphasis on higher margin units, as well as developing innovative new casual lifestyle footwear platforms. By streamlining the product portfolio and reducing non-core product development, we believe we will create a more powerful consumer connection to the brand.

We are refining our business model around the world, prioritizing direct investment in larger-scale geographies to focus our resources on the demographics with the largest growth prospects, moving away from direct investment in the retail and wholesale businesses in smaller markets, and transferring significant commercial responsibilities to distributors and other third-parties. Further, we intend to expand our engagement with leading wholesale accounts in select markets to drive sales growth, optimize product placement and enhance brand reputation.


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Comparison of Three Months Ended September 30, 2017 to Three Months Ended September 30, 2016

Results of Operations
 
Three Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
 
(in thousands, except per share, margin, unit sales, and average selling price data)
Revenues
$
243,273

 
$
245,888

 
$
(2,615
)
 
(1.1
)%
Cost of sales
119,810

 
123,454

 
(3,644
)
 
(3.0
)%
Gross profit
123,463

 
122,434

 
1,029

 
0.8
 %
Selling, general and administrative expenses
120,778

 
123,649

 
(2,871
)
 
(2.3
)%
Income (loss) from operations
2,685

 
(1,215
)
 
3,900

 
321.0
 %
Foreign currency gain (loss), net
(257
)
 
1,379

 
(1,636
)
 
(118.6
)%
Interest income
269

 
178

 
91

 
51.1
 %
Interest expense
(167
)
 
(184
)
 
17

 
9.2
 %
Other income (expense)
54

 
(1
)
 
55

 
5,500.0
 %
Income before income taxes
2,584

 
157

 
2,427

 
1,545.9
 %
Income tax expense
955

 
1,690

 
(735
)
 
(43.5
)%
Net income (loss)
1,629

 
(1,533
)
 
3,162

 
206.3
 %
Dividends on Series A convertible preferred stock
(3,000
)
 
(3,000
)
 

 
 %
Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion feature
(892
)
 
(819
)
 
(73
)
 
(8.9
)%
Net loss attributable to common stockholders
$
(2,263
)
 
$
(5,352
)
 
$
3,089

 
57.7
 %
Net loss per common share:
 

 
 

 
 
 
 
Basic
$
(0.03
)
 
$
(0.07
)
 
$
0.04

 
57.1
 %
Diluted
$
(0.03
)
 
$
(0.07
)
 
$
0.04

 
57.1
 %
 
 
 
 
 
 
 
 
Gross margin
50.8
%
 
49.8
 %
 
100

 
2.0
 %
Operating margin
1.1
%
 
(0.5
)%
 
160

 
320.0
 %
Footwear unit sales
13,050

 
12,135

 
915

 
7.5
 %
Average footwear selling price
$
18.17

 
$
19.96

 
$
(1.79
)
 
(9.0
)%

Revenues. Revenues decreased $2.6 million, or 1.1%, in the three months ended September 30, 2017, compared to the same period in 2016. The revenues decreased primarily due to the sale of our Taiwan business in the fourth quarter of 2016, the sale of our Middle East business in the second quarter of 2017, targeted reductions in the number of company-operated retail stores, and additional actions taken to optimize our wholesale, retail, and e-commerce channels. Lower average footwear selling prices reduced revenues by approximately $22.5 million, or 9.0%, as our product, store, and channel mix continued to change. This was partially offset by higher sales volumes, which increased revenues by $18.6 million, or 7.5%, and by an increase of $1.3 million, or 0.5%, from foreign currency translation.
 
Cost of sales. During the three months ended September 30, 2017, cost of sales decreased $3.6 million, or 3.0%, compared to the same period in 2016. Lower average costs per unit were primarily the result of product mix, reflecting our ongoing focus on core molded products, which cost less to produce, and continued supply chain cost reductions, including a reallocation of third-party manufacturing production to lower-cost suppliers within the Asia Pacific region. Lower average costs per unit reduced cost of sales by approximately $13.6 million, or 11.1%, which was partially offset by an increase due to higher unit sales volume of $9.3 million, or 7.5%, and by an increase of $0.7 million, or 0.6%, from foreign currency translation.
 
Gross profit. During the three months ended September 30, 2017, gross profit increased $1.0 million, or 0.8%, and gross margin increased 100 basis points to 50.8%, compared to the same period in 2016. The increase in gross profit was primarily due to our continued focus on sales of higher margin products. Increases of approximately $9.2 million, or 7.5%, resulting from higher sales

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unit volumes and $0.6 million, or 0.5%, from foreign currency translation, were offset in part by a decrease of $8.8 million, or 7.2%, which resulted from a decline in our average selling prices that exceeded the decrease in our average costs per unit.
 
Selling, general and administrative expenses. SG&A decreased $2.9 million, or 2.3%, during the three months ended September 30, 2017, compared to the same period in 2016. The decrease was primarily due to the combined impacts of a decrease in facilities expenses of $3.9 million, as a result of fewer company-operated retail stores and the sales of our Taiwan and Middle East businesses, and lower retail store impairment expense of $0.8 million. These savings were offset in part by higher stock compensation expense of $0.8 million and higher services and other expenses of $1.0 million, none of which were individually significant.

Foreign currency gain, net. Foreign currency gain, net, consists of unrealized and realized foreign currency gains and losses from the remeasurement and settlement of monetary assets and liabilities denominated in non-functional currencies, and realized and unrealized gains and losses on foreign currency derivative instruments. During the three months ended September 30, 2017, we recognized realized and unrealized net foreign currency losses of $0.3 million compared to net gains of $1.4 million during the three months ended September 30, 2016.
 
Income tax expense. During the three months ended September 30, 2017, income tax expense decreased $0.7 million compared to the same period in 2016. The effective tax rate for the three months ended September 30, 2017 was 37.0% compared to an effective tax rate of 1,076.4% for the same period in 2016, a 1,039.4% decrease. The 2016 effective tax rate was atypical as a result of the amount of income tax expense as compared to low income before income taxes for the period. Additionally, there is an impact due to operating losses in certain jurisdictions where the Company has determined that it is not more likely than not to realize the associated tax benefits, partially offset by tax expense recorded in profitable jurisdictions. Our effective tax rate of 37.0% for the three months ended September 30, 2017 differs from the federal U.S. statutory rate primarily due to differences in income tax rates between U.S. and foreign jurisdictions as well as book losses in certain jurisdictions for which tax benefits cannot be recognized.

Revenues By Channel
 
 
Three Months Ended September 30,
 
Change
 
Constant Currency
Change 
(1)
 
 
2017
 
2016
 
$
 
%
 
$
 
%
 
 
(in thousands)
Wholesale:
 
 

 
 

 
 

 
 

 
 

 
 

Americas
 
$
41,642

 
$
41,389

 
$
253

 
0.6
 %
 
$
153

 
0.4
 %
Asia Pacific
 
41,005

 
45,565

 
(4,560
)
 
(10.0
)%
 
(4,034
)
 
(8.9
)%
Europe
 
23,857

 
21,909

 
1,948

 
8.9
 %
 
604

 
2.8
 %
Other businesses
 
254

 
271

 
(17
)
 
(6.3
)%
 
(28
)
 
(10.3
)%
Total wholesale
 
106,758

 
109,134

 
(2,376
)
 
(2.2
)%
 
(3,305
)
 
(3.0
)%
Retail:
 
 

 
 

 
 

 
 

 
 

 
 

Americas
 
57,404

 
56,607

 
797

 
1.4
 %
 
689

 
1.2
 %
Asia Pacific
 
29,497

 
37,259

 
(7,762
)
 
(20.8
)%
 
(7,213
)
 
(19.4
)%
Europe
 
12,434

 
13,194

 
(760
)
 
(5.8
)%
 
(1,457
)
 
(11.0
)%
Total retail
 
99,335

 
107,060

 
(7,725
)
 
(7.2
)%
 
(7,981
)
 
(7.5
)%
E-commerce:
 


 


 


 


 


 
 

Americas
 
21,413

 
16,662

 
4,751

 
28.5
 %
 
4,668

 
28.0
 %
Asia Pacific
 
9,537

 
8,096

 
1,441

 
17.8
 %
 
1,708

 
21.1
 %
Europe
 
6,230

 
4,936

 
1,294

 
26.2
 %
 
974

 
19.7
 %
Total e-commerce
 
37,180

 
29,694

 
7,486

 
25.2
 %
 
7,350

 
24.8
 %
Total revenues
 
$
243,273

 
$
245,888

 
$
(2,615
)
 
(1.1
)%
 
$
(3,936
)
 
(1.6
)%
(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. Constant currency represents current period results that have been retranslated using exchange rates in effect in the prior comparative period.
Wholesale channel revenues. During the three months ended September 30, 2017, revenues from our wholesale channel decreased $2.4 million, or 2.2%, compared to the same period in 2016. Wholesale revenues decreased due to the sale of our Taiwan business in the fourth quarter of 2016 and reduced sales in our Asia-Pacific segment as we continue to pursue business model changes to drive higher quality revenues and improve profitability across Asia. An increase of approximately $10.3 million, or 9.4%, from

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higher sales volumes, was offset by a decrease of $13.6 million, or 12.5%, attributable to lower average selling prices, while an increase of $0.9 million, or 0.9%, resulted from foreign currency translation.
  
Retail channel revenues. During the three months ended September 30, 2017, revenues from our retail channel decreased $7.7 million or 7.2%, compared to the same period in 2016. The decrease in retail channel revenues compared to the same period in 2016 was due primarily to our declining full-price store count, consistent with our store rationalization plan, as well as lower average selling prices as we shift to lower-priced molded product. We operated 80 fewer stores compared to the end of last year’s third quarter, achieving a net decrease of 29 company-operated retail store locations in the third quarter of 2017. Approximately $3.3 million, or 3.1%, of the decrease resulted from lower sales volumes, a decrease of $4.6 million, or 4.3%, was attributable to lower average selling prices, partially offset by an increase of $0.2 million, or 0.2%, from foreign currency translation.

E-commerce channel revenues. During the three months ended September 30, 2017, revenues from our e-commerce channel increased $7.5 million, or 25.2%, compared to the same period in 2016, as this channel continued to grow in importance to our overall business. Revenues increased by $8.8 million, or 29.7%, from higher sales volumes, were offset in part by a decrease of $1.4 million, or 5.0%, due to lower average selling prices, while foreign currency translation resulted in an increase of $0.1 million, or 0.5%.

Future changes in average selling prices will be impacted by: (i) the mix of products sold, (ii) the sales channel under which the sales are made (as we generally realize higher sales prices from our retail and e-commerce channels as compared to our wholesale channel), and (iii) the level of sales discounts and incentives we offer our customers.


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Comparison of the Three Months Ended September 30, 2017 and 2016 by Reportable Operating Segment

The following table sets forth information related to our reportable operating segments, including a comparison of revenues and operating income by segment:
 
Three Months Ended September 30,
 
Change
 
Constant Currency
Change (1)
 
2017
 
2016
 
$
 
%
 
$
 
%
 
(in thousands)
Revenues:
 

 
 

 
 

 
 

 
 

 
 

Americas
$
120,459

 
$
114,658

 
$
5,801

 
5.1
 %
 
$
5,510

 
4.8
 %
Asia Pacific
80,039

 
90,920

 
(10,881
)
 
(12.0
)%
 
(9,539
)
 
(10.5
)%
Europe
42,521

 
40,039

 
2,482

 
6.2
 %
 
121

 
0.3
 %
  Total segment revenues
243,019

 
245,617

 
(2,598
)
 
(1.1
)%
 
(3,908
)
 
(1.6
)%
Other businesses
254

 
271

 
(17
)
 
(6.3
)%
 
(28
)
 
(10.3
)%
Total revenues
$
243,273

 
$
245,888

 
$
(2,615
)
 
(1.1
)%
 
$
(3,936
)
 
(1.6
)%
 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) from operations:
 
 
 
 
 

 
 

 
 

 
 

Americas
$
24,102

 
$
16,329

 
$
7,773

 
47.6
 %
 
$
7,377

 
45.2
 %
Asia Pacific
13,264

 
17,303

 
(4,039
)
 
(23.3
)%
 
606

 
3.5
 %
Europe
5,416

 
1,751

 
3,665

 
209.4
 %
 
570

 
32.6
 %
  Total segment operating income
42,782

 
35,383

 
7,399

 
20.9
 %
 
8,553

 
24.2
 %
Other businesses (2)
(6,233
)
 
(7,179
)
 
946

 
13.2
 %
 
2,149

 
29.9
 %
Unallocated corporate and other (3)
(33,864
)
 
(29,419
)
 
(4,445
)
 
(15.1
)%
 
(4,964
)
 
(16.9
)%
Total operating income (loss)
$
2,685

 
$
(1,215
)
 
$
3,900

 
321.0
 %
 
$
5,738

 
472.3
 %
(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. Constant currency represents current period results that have been retranslated using exchange rates in effect in the prior comparative period.
(2) Other businesses consists primarily of our owned and leased manufacturing facilities, which manufacture products for sale by our operating segments.