Crocs, Inc.: Form 10-Q for the period ended Mar 31, 2021

Business Overview

Crocs, Inc. and our consolidated subsidiaries (collectively the “Company,” “Crocs,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for men, women, and children. We strive to be the world leader in innovative casual footwear for women, men, and children, combining comfort and style with a value that consumers want. The vast majority of shoes within our collection contain Croslite™ material, a proprietary, molded footwear technology, delivering extraordinary comfort with each step.

Known or Anticipated Trends

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

• Our revenue grew in the three months ended March 31, 2021, despite challenging global logistics that impacted many industries around the world, including the blockage of the Suez Canal, which we expect to have a more significant impact on operations in the second quarter of 2021, and significant bottlenecks in West Coast ports, which had an impact on first quarter 2021 operations and is expected to continue to impact future quarters this year. We continue to be proactive in our supervision of this global logistics congestion.
• Our new EMEA distribution center in Dordrecht, the Netherlands, opened in the three months ended March 31, 2021 and the expansion of our U.S. distribution center is underway. In 2021, we expect an impact to gross margin of approximately $12 to $15 million related to distribution center investments to fuel our future growth.
• Capital expenditures for supply chain investments to support our growth are expected to be between $100 and $130 million for 2021.
• Digital sales, which include sales through our company-owned websites, third party marketplaces, and e-tailers, continued to show significant growth in the three months ended March 31, 2021 compared to the same period in 2020. We expect this trend to continue on an ongoing basis.
• While the vast majority of our company-operated retail stores were open at March 31, 2021, we continued to experience store closures, primarily in Western Europe, throughout the first quarter of 2021, as a result of the COVID-19 pandemic. Additionally, our year-over-year results discussed below are, and we expect for the remainder of 2021 will be, impacted to some extent by prior year store closures and operating hour reductions during COVID-19.
• In April 2021, the Board of Directors (the “Board”) approved a $712.2 million increase to our share repurchase authorization, after which $1.0 billion remained available for future common stock repurchases.

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 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 rates on reported amounts.

Management uses constant currency to assist in comparing business trends from period to period on a consistent basis in communications with the Board, stockholders, analysts, and investors concerning our financial performance. We believe constant currency is useful to investors and other users of our condensed consolidated financial statements as an additional tool to evaluate operating performance and trends. Investors should not consider constant currency in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP.

First Quarter 2021 Financial and Operational Highlights

Revenues were $460.1 million for the first quarter of 2021, a 63.6% increase compared to the first quarter of 2020. The increase was due to the net effects of: (i) higher unit sales volumes, which increased revenues by $158.3 million, or 56.3%, driven by increased consumer demand for our product, a portion of which was due to improved sales in our wholesale and retail businesses as the pandemic subsides, and continued e-commerce growth; (ii) higher average selling prices, driven primarily by reduced promotions and higher pricing, which increased revenues by $12.0 million, or 4.2%; and (iii) favorable changes in exchange rates, which increased revenues by $8.6 million, or 3.1%.

The following were significant developments affecting our businesses and capital structure during the three months ended March 31, 2021:

• We sold 25.9 million pairs of shoes worldwide, an increase from 17.1 million pairs in the first quarter of 2020.
• Revenues in our Americas segment grew by 87.1%. Our EMEA segment revenues grew by 48.8%, or 41.0% on a constant currency basis, and our Asia segment revenues grew by 26.2%, or 20.1% on a constant currency basis, compared to the first quarter of 2020.
• Digital sales represented 32.3% of revenue, compared to 30.1% in last year’s first quarter.
• Gross margin was 55.0%, an increase of 730 basis points from last year’s first quarter, as a result of favorable channel and product mix, reduced discounting, and efficiencies in our distribution and logistics network.
• SG&A was $128.5 million compared to $113.4 million in the first quarter of 2020. As a percent of revenues, SG&A decreased to 27.9% of revenues compared to 40.3% of revenues in the first quarter of 2020.
• Income from operations increased to $124.7 million from $20.8 million in last year’s first quarter. Net income was $98.4 million, or $1.47 per diluted share, compared to $11.1 million, or $0.16 per diluted share, in last year’s first quarter.
• We repurchased 1.1 million shares of our common stock at a cost of $50.0 million, including commissions. This includes 0.5 million shares delivered in January 2021 at the conclusion of the purchase period for an accelerated share repurchase arrangement (“ASR”) entered into in the fourth quarter of 2020.
• During the first quarter, we issued $350.0 million of 4.250% senior notes due 2029 and repaid the then-outstanding balance of $115.0 million under our senior revolving credit facility with a portion of the proceeds. At March 31, 2021, we had $499.7 million in available borrowing capacity.

Results of Operations

(in thousands, except per share, margin, and average selling price data)

(1) Changes for gross margin and operating margin are shown in basis points (“bp”).

(2) Average footwear selling price is calculated as footwear and charms revenues divided by footwear units.

Revenues By Channel

(in thousands)

(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information.

(2) Direct-to-consumer revenues consist of sales generated through our company-operated retail stores (previously our “Retail” channel) and company-operated e-commerce websites and third-party e-commerce marketplaces (previously our “E-commerce” channel).

The primary drivers of changes in revenue were:

(in thousands)

(1) The change due to price is based on the change in average selling price on a constant currency basis (“ASP”).

Revenues. In the three months ended March 31, 2021, revenues increased compared to the same period in 2020. This was mostly driven by sales volume increases in all regions, most significantly in our Americas and EMEA segments. The volume increase was due to increased consumer demand, attributable in part to the negative impact of the COVID-19 pandemic on prior year wholesale and retail store sales, and continued e-commerce growth led by the Americas. Higher ASP, due to less promotional activity and higher pricing, led to higher Americas and Asia Pacific revenues, particularly in our direct-to-consumer channel. Foreign exchange fluctuations also increased revenues, primarily due to favorable changes in the Euro and numerous other currencies, offset in part by unfavorable changes in the Russian Ruble and Brazilian Real.

Cost of sales. In the three months ended March 31, 2021, compared to the same period in 2020, cost of sales increased due to higher volume of $75.1 million, or 51.1%, primarily in our Americas and EMEA segments, and foreign currency fluctuations, which increased cost of sales by $4.3 million, or 2.9%, offset in part by lower average cost per unit on a constant currency basis (“AUC”), primarily in our wholesale channel, as a result of increased efficiencies in our distribution and logistics network, which decreased cost of sales by $19.5 million, or 13.3%.

Gross profit. Gross margin increased in the three months ended March 31, 2021 to 55.0%, compared to 47.7% in the same period in 2020, driven by favorable channel and product mix, reduced discounting, and efficiencies in our distribution and logistics network. Gross profit increased $119.1 million, or 88.7%, as a result of higher volume of $83.2 million, or 62.0%, the combined impact of lower AUC and higher ASP, of $31.5 million, or 23.4%, and favorable foreign currency changes of $4.4 million, or 3.3%.

Selling, general and administrative expenses. SG&A as a percent of revenue improved to 27.9% in the three months ended March 31, 2021 from 40.3% in the same period in 2020 as a result of strong sales growth and our continued efforts to leverage operating costs. SG&A expenses increased $15.2 million, or 13.4%, in the three months ended March 31, 2021 compared to the same period in 2020 The primary driver of this increase was higher compensation expense, which increased $12.2 million as a result of higher variable and executive compensation and an increase in employee headcount over prior year. Additionally, professional services costs increased $3.5 million due to higher consulting fees associated with supply chain investments and higher variable credit card fees associated with increased direct-to-consumer sales. Facilities costs increased $2.2 million, driven by higher variable rent associated with higher retail sales, and other net costs, including information technology, increased $1.9 million. These increases were partially offset by lower bad debt expense of $4.6 million, primarily as a result of a charge taken in prior year in response to COVID-19 that did not recur in 2021 and collections on previously reserved bad debt expense.

Foreign currency losses, net. Foreign currency losses, net, consist of realized and unrealized foreign currency gains and losses from the remeasurement and settlement of monetary assets and liabilities denominated in non-functional currencies as well as realized and unrealized gains and losses on foreign currency derivative instruments. During the three months ended March 31, 2021, we recognized realized and unrealized net foreign currency losses of $0.5 million, compared to losses of $0.2 million during the three months ended March 31, 2020.

Income tax expense. During the three months ended March 31, 2021, income tax expense increased $16.5 million compared to the same period in 2020. The effective tax rate for the three months ended March 31, 2021 was 19.7% compared to an effective tax rate of 40.9% for the same period in 2020, a 21.2% decrease. This decrease in the effective rate was driven primarily by the realization of deferred tax assets which were subject to a valuation allowance. Our 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 the realization of deferred tax assets which were subject to a valuation allowance.

Reportable Operating Segments

The following table sets forth information related to our reportable operating segments, including a comparison of revenues and operating income by segment:

(in thousands)

(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information.

(2) In the first quarter of 2021, certain costs previously reported within ‘Other Businesses’ were shifted to the Americas, Asia Pacific, and EMEA segments to reflect changes in the way management evaluates segment performance, makes operating decisions, and allocates resources. Additionally, any costs remaining in ‘Other Businesses’ have been consolidated into ‘Unallocated corporate and other.’ The previously reported amounts for income from operations for the three months ended March 31, 2020 have been revised to conform to current period presentation. See the ‘Impacts of segment composition change’ table below for more information.

(3) Unallocated corporate and other includes corporate support and administrative functions, certain royalty income, costs associated with share-based compensation, research and development, brand marketing, legal, and depreciation and amortization of corporate and other assets not allocated to operating segments.

Impacts of segment composition change:

(in thousands)

22

The primary drivers of changes in revenues by operating segment were:

(in thousands)

(1) The change due to price for revenues is based on ASP, as defined earlier in this section.

Americas Operating Segment

Revenues. Americas revenues increased in the three months ended March 31, 2021, compared to the same period in 2020, largely due to higher volumes in both our wholesale and direct-to-consumer channels, driven by increased consumer demand and strong wholesale sell-through, which resulted in more wholesale orders and deliveries. Revenues also increased 4.0% as a result of increased ASP in our direct-to-consumer channel from less promotional activity, partially offset by decreased ASP in our wholesale channel due in part to product mix. These increases were slightly offset by unfavorable foreign currency changes, primarily in the Brazilian Real.

Income from Operations. Income from operations for our Americas segment was $118.3 million for the three months ended March 31, 2021, an increase of $78.4 million, or 196.3%, compared to the same period in 2020. Gross profit increased $85.1 million, or 112.1%, as a result of higher volume of $66.6 million, or 87.7%, in both channels, and higher ASP, supplemented by lower AUC, of $18.7 million, or 24.7%, due to fewer promotions, favorable product mix, and increased efficiencies at our U.S. distribution center. Insignificant unfavorable currency changes minimally offset these increases.

SG&A for our Americas segment increased $6.7 million, or 18.6%, during the three months ended March 31, 2021 compared to the same period in 2020. This increase was driven by higher marketing costs of $2.2 million due to variable marketing associated with higher revenues, higher compensation cost of $1.8 million due to increased headcount, higher facilities costs of $1.4 million from variable rent associated with an increase in retail sales, and increases in other net costs of $1.3 million, mostly as a result of variable costs associated with higher sales, offset by collections on previously reserved bad debt expense.

Asia Pacific Operating Segment

Revenues. Asia Pacific revenues increased in the three months ended March 31, 2021, compared to the same period in 2020, as a result of higher ASP in both channels, as a result of price increases, less promotional activity, and favorable changes in product mix, and higher volume, particularly in our wholesale channel as a result of prior year COVID-19 closures that did not recur in the current year. Favorable foreign currency fluctuations, primarily in the Korean Won, also increased revenues.

Income from Operations. Income from operations for the Asia Pacific segment was $23.3 million for the three months ended March 31, 2021, an increase of $14.0 million, or 151.9%, compared to the same period in 2020. Gross profit increased by $12.1 million, or 37.5%, mostly from ASP growth that outpaced AUC growth of $8.6 million, or 26.7%. Additionally, favorable changes in currency of $2.2 million, or 6.9%, and higher volume of $1.3 million, or 3.9%, contributed gross profit gains over the same period in the prior year.

SG&A for our Asia Pacific segment decreased $1.9 million, or 8.5%, during the three months ended March 31, 2021, compared to the same period in 2020. This decrease was due to lower bad debt expense of $3.0 million, primarily from a charge taken in the prior year in response to COVID-19, and prior year inventory donations to healthcare workers and other organizations of $1.2 million, neither of which recurred in 2021. These decreases were offset in part by higher marketing costs of $1.2 million, mostly due to an increased investment in our China business, and higher facilities and other net costs of $1.1 million.

EMEA Operating Segment

Revenues. Revenues increased in our EMEA segment in the three months ended March 31, 2021, compared to the same period in 2020, driven almost entirely by increased volume in our wholesale channel. This increase was a result of higher sales in our distributor markets that were heavily impacted last year by the COVID-19 pandemic and general increased demand for our products across the region. Positive net foreign currency fluctuations, mostly in the Euro, were partially offset by lower ASP, driven primarily by changes in channel mix.

Income from Operations. Income from operations for the EMEA segment was $37.1 million for the three months ended March 31, 2021, an increase of $19.3 million, or 108.0%, compared to the same period in 2020. Gross profit increased $20.4 million, or 67.0%, due to higher volume of $13.6 million, or 44.8%. Additionally, favorable purchasing power from currency changes drove lower AUC, partially offset by lower ASP, of $4.2 million, or 13.7%, and favorable foreign currency fluctuations impacted gross profit by $2.6 million, or 8.5%.

SG&A for our EMEA segment increased $1.1 million, or 9.0%, during three months ended March 31, 2021, compared to the same period in 2020, primarily from higher marketing costs of $1.4 million, partially offset by decreases in other net costs of $0.3 million.

Unallocated Corporate and Other

During the three months ended March 31, 2021, total net costs within ‘Unallocated Corporate and Other’ increased $7.8 compared to the same period in 2020. This change was driven primarily by higher compensation expense of $9.9 million primarily as a result of higher variable and executive compensation and an increase in employee headcount, higher information technology costs of $2.0 million, and higher professional services costs of $2.0 million from higher consulting fees associated with supply chain investments. These increases were offset by lower unallocated marketing costs of $3.7 million and lower other net costs of $2.4 million.

Store Locations and Comparable Sales

The tables below illustrate the overall change in the number of our company-operated retail locations by reportable operating segment for the three months ended March 31, 2021:

Digital sales, which includes sales through our company-owned websites, third party marketplaces, and e-tailers (which are reported in our wholesale channel), as a percent of total revenues, by operating segment were:

24

Comparable direct-to-consumer sales by operating segment are shown below.

(1) Reflects period over period change on a constant currency basis, which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information.

(2) Comparable store status is determined on a monthly basis. Comparable store sales includes the revenues of stores that have been in operation for more than twelve months. Stores in which selling square footage has changed more than 15% as a result of a remodel, expansion, or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily closed stores are excluded from the comparable store sales calculation during the month of closure and in the same month in the following year. Location closures in excess of three months are excluded until the thirteenth month post re-opening. E-commerce revenues are based on same site sales period over period.

Financial Condition, Capital Resources, and Liquidity

Liquidity

Our liquidity position as of March 31, 2021 was:

(in thousands)

As of March 31, 2021, we had $255.9 million in cash and cash equivalents and up to $499.7 million of remaining borrowing availability under our Facility (as defined below). We believe that cash flows from operations, our cash and cash equivalents on hand, and available borrowings under our Facility will be sufficient to meet our ongoing liquidity needs and capital expenditure requirements for at least the next twelve months. Additionally, in March 2021, we completed the issuance and sale of $350.0 million aggregate principal amount of 4.250% Senior Notes due March 15, 2029. A portion of the net proceeds were used to repay the then-outstanding balance of $115.0 million under our Facility and we intend to use the remainder for general corporate purposes, which may include working capital, capital expenditures, stock repurchases, and acquisitions. See “Senior Notes Issuance” below for more information. Further, in April 2021, the Board approved a $712.2 million increase to our share repurchase authorization, after which $1.0 billion remained available for future common stock repurchases.

Additional future financing may be necessary to fund our operations, and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all. Although we believe we have adequate sources of liquidity over the long term, the success of our operations, the global economic outlook, and the pace of sustainable growth in our markets, among other factors, could impact our business and liquidity.

Repatriation of Cash

As a global business, we have cash balances in various countries and amounts are denominated in various currencies. Fluctuations in foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in foreign currencies may have a material impact on our cash flows and capital resources. Cash balances held in foreign countries may have additional restrictions and covenants associated with them which could adversely impact our liquidity and our ability to timely access and transfer cash balances between entities.

All of the cash held outside of the U.S. could be repatriated to the U.S. without incurring additional U.S. federal income taxes. As of March 31, 2021, we held $67.2 million of our total $255.9 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. The repatriation of the $67.2 million held in international locations is not limited by local regulations.

Senior Revolving Credit Facility

In July 2019, the Company and certain of our subsidiaries (the “Borrowers”) entered into a Second Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders, which provided for a revolving credit facility of $500.0 million, which can be increased by an additional $100.0 million subject to certain conditions (the “Facility”). Borrowings under the Credit Agreement bear interest at a variable rate based on (A) a domestic base rate (defined as the highest of (i) the Federal Funds open rate, plus 0.25%, (ii) the Prime Rate, and (iii) the Daily LIBOR rate, plus 1.00%), plus an applicable margin ranging from 0.25% to 0.875% based on our leverage ratio, or (B) a LIBOR rate, plus an applicable margin ranging from 1.25% to 1.875% based on our leverage ratio. Borrowings under the Credit Agreement are secured by all of the assets of the Borrowers and guaranteed by certain other subsidiaries of the Borrowers.

The Credit Agreement requires us to maintain a minimum interest coverage ratio of 4.00 to 1.00, and a maximum leverage ratio of (i) 3.50 to 1.00 from the quarter ended December 31, 2020 to the quarter ended December 31, 2021, and (ii) 3.25 to 1.00 from the quarter ended March 31, 2022 and thereafter (subject to adjustment in certain circumstances). The Credit Agreement permits (i) stock repurchases subject to certain restrictions, including after giving effect to such stock repurchases, the maximum leverage ratio does not exceed certain levels; and (ii) certain acquisitions so long as there is borrowing availability under the Credit Agreement of at least $40.0 million. As of March 31, 2021, we were in compliance with all financial covenants under the Credit Agreement.

As of March 31, 2021, the total commitments available from the lenders under the Facility were $500.0 million. At March 31, 2021, we had no outstanding borrowings and $0.3 million in outstanding letters of credit under the Facility, which reduces amounts available for borrowing under the Facility. As of March 31, 2021 and December 31, 2020, we had $499.7 million and $319.4 million, respectively, of available borrowing capacity under the Facility.

Asia Revolving Credit Facilities

We have two revolving credit facilities in Asia, the revolving credit facility with China Merchants Bank Company Limited, Shanghai Branch, which provides up to 30.0 million RMB, or $4.6 million at current exchange rates, and matures in May 2021, and the revolving credit facility with Citibank (China) Company Limited, Shanghai Branch, which provides up to an equivalent of $5.0 million and matures in June 2021.

We had no borrowings under our Asia revolving facilities during the three months ended March 31, 2021 and year ended December 31, 2020 or borrowings outstanding at March 31, 2021 and December 31, 2020.

Senior Notes Issuance

On March 12, 2021, the Company completed the issuance and sale of $350.0 million aggregate principal amount of 4.250% Senior Notes due March 15, 2029 (the “Notes”), pursuant to the indenture related thereto (“the Indenture”). Interest on the Notes is payable semi-annually.

The Notes rank pari passu in right of payment with all of the Company’s existing and future senior debt, including the Credit Agreement, and are senior in right of payment to any of the Company’s future debt that is, by its term, expressly subordinated in right of payment to the Notes. The Notes are unconditionally guaranteed by each of the Company’s restricted subsidiaries that is a borrower or guarantor under the Credit Agreement and by each of the Company’s wholly-owned restricted subsidiaries that guarantees any debt of the Company or any guarantor under any syndicated credit facility or capital markets debt in an aggregate principal amount in excess of $25.0 million.

The Company will have the option to redeem all or any portion of the Notes, at once or over time, at any time on or after March 15, 2024, at a redemption price equal to 100% of the principal amount thereof, plus a premium declining ratably on an annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company will also have the option to redeem some or all of the Notes at any time before March 15, 2024 at a redemption price of 100% of the principal amount of the Notes to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before March 15, 2024, the Company may redeem up to 40% of the aggregate principal amount of the Notes at a redemption price of 104.250% of the principal amount of the Notes with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption.

The Indenture contains covenants that, among other things, limit the ability of the Company and its restricted subsidiaries to incur additional debt or issue certain preferred stock; pay dividends or repurchase or redeem capital stock or make other restricted payments; declare or pay dividends or other payments; incur liens; enter into certain types of transactions with the Company’s affiliates; and consolidate or merge with or into other companies. As of March 31, 2021, we were in compliance with all financial covenants under the Notes.

Cash Flows

(in thousands)

Operating Activities. Cash provided by operating activities consists of net income adjusted for noncash items and changes in working capital. Cash provided by operating activities increased $115.1 million for the three months ended March 31, 2021 compared to the three months ended March 31, 2020, driven by higher net income, adjusted for non-cash items, of $84.7 million and by net increases in operating assets and liabilities of $30.4 million in line with the growth of our business.

Investing Activities. There was an $8.2 million decrease in cash used in investing activities for the three months ended March 31, 2021 compared to the three months ended March 31, 2020. The decrease is primarily due to a decrease in the purchases of property, equipment, and software, mainly from expenditures in 2020 that did not recur in the current year related to the relocation of our Corporate headquarters.

Financing Activities. Cash provided by financing activities decreased by $0.9 million in the three months ended March 31, 2021 compared to the three months ended March 31, 2020. This decrease was primarily driven by a $325.0 million decrease in borrowings, net of repayments, on our Facility. Increases in repurchases of our common stock and repurchases of common stock for tax withholding of $10.9 million and $7.9 million, respectively, also contributed to the overall decrease of cash provided by financing activities. The overall decrease was offset by an increase of $350.0 million in proceeds from the Notes issuance, net of a decrease of $7.1 million paid in deferred debt issuance costs, primarily related to the Notes.

Contractual Obligations

There have been no significant changes to the contractual obligations reported in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, other than (i) borrowings and repayments on the Facility and the issuance of the Notes, as described above; and (ii) in the three months ended March 31, 2021, we signed contracts to further expand our U.S. distribution center, resulting in (a) future lease payments of approximately $31 million through 2030, as described in Note 4 — Leases in the accompanying notes to the condensed consolidated financial statements included in Part I - Item 1. Financial Statements of this Quarterly Report on Form 10-Q, and (b) other contractual commitments of approximately $45 million through 2022, the majority of which is expected to be paid during 2021.

Off-Balance Sheet Arrangements

We had no material off-balance sheet arrangements as of March 31, 2021, other than certain purchase commitments, which are described in Note 13 — Commitments and Contingencies in the accompanying notes to the condensed consolidated financial statements included in Part I - Item 1. Financial Statements of this Quarterly Report on Form 10-Q.

Critical Accounting Policies and Estimates

The preparation of these condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales, and expenses, and related disclosure of contingent assets and liabilities. We evaluate our assumptions and estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

For a complete discussion of our critical accounting policies, please refer to our Annual Report on Form 10-K for the year ended December 31, 2020 and Note 2 — Recent Accounting Pronouncements in the accompanying notes to the condensed consolidated financial statements included in Part I - Item 1. Financial Statements of this Quarterly Report on Form 10-Q. There have been no other significant changes in our critical accounting policies or their application since December 31, 2020.

Recent Accounting Pronouncements

See Note 2 — Recent Accounting Pronouncements in the accompanying notes to the condensed consolidated financial statements included in Part I - Item 1. Financial Statements of this Quarterly Report on Form 10-Q for a description of recently adopted accounting pronouncements and issued accounting pronouncements that we believe may have an impact on our condensed consolidated financial statements when adopted.

Interest Rate Risk

We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences, and overall financing strategies. Our exposure to market risk includes interest rate fluctuations in connection with our Facility and certain financial instruments.

Borrowings under our Facility bear interest at a variable rate and are therefore subject to risk based upon prevailing market interest rates. Interest rates fluctuate as a result of many factors, including governmental monetary and tax policies, domestic and international economic and political considerations, and other factors that are beyond our control.

As of March 31, 2021, we had long-term borrowings with a face value of $350.0 million, comprised of fixed rate senior notes, and $0.3 million in outstanding letters of credit under our Facility. As of December 31, 2020, we had $180.0 million in outstanding borrowings and $0.6 million in outstanding letters of credit under our Facility.

A hypothetical increase of 1% in the interest rate on these borrowings would have increased interest expense by $0.3 million for the three months ended March 31, 2021.

Foreign Currency Exchange Risk

Changes in exchange rates have a direct effect on our reported U.S. Dollar condensed consolidated financial statements because we translate the operating results and financial position of our international subsidiaries to U.S. Dollars using current period exchange rates. Specifically, we translate the statements of operations of our foreign subsidiaries into the U.S. Dollar reporting currency using exchange rates in effect during each reporting period. As a result, comparisons of reported results between reporting periods may be impacted significantly due to differences in the exchange rates in effect at the time such exchange rates are used to translate the operating results of our international subsidiaries.

An increase of 1% of the value of the U.S. Dollar relative to foreign currencies would have decreased our revenues during the three months ended March 31, 2021 by $1.9 million. The volatility of the exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy.

We may enter into forward foreign exchange contracts to buy or sell various foreign currencies to selectively protect against volatility in the value of non-functional currency denominated monetary assets and liabilities. Changes in the fair value of these forward contracts are recognized in earnings in the period that the changes occur. As of March 31, 2021, the U.S. Dollar notional value of our outstanding foreign currency forward exchange contracts was approximately $145.2 million. The net fair value of these contracts at March 31, 2021 was an asset of $0.5 million.

We perform a sensitivity analysis to determine the effects that market risk exposures may have on the fair values of our foreign currency forward exchange contracts. To perform the sensitivity analysis, we assess the risk of changes in fair values from the effect of hypothetical changes in foreign currency exchange rates. This analysis assumes a like movement by the foreign currencies in our hedge portfolio against the U.S. Dollar. As of March 31, 2021, a 10% appreciation in the value of the U.S. Dollar would result in a net increase in the fair value of our derivative portfolio of approximately $0.9 million.

See Part I - Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Quarterly Report on Form 10-Q for a discussion of the impact of the change in foreign exchange rates on our U.S. Dollar condensed consolidated statements of operations for the three and three months ended March 31, 2021 and 2020.

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures as such item is defined under Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2021, to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the three months ended March 31, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes to the risk factors contained in our Annual Report on Form 10-K for the year ended December 31, 2020.