Wyndham Hotels & Resorts, Inc.: Form 10-Q for the period ended Sep 30, 2023

(Unless otherwise noted, all amounts are in millions, except share and per share amounts)

Forward-Looking Statements

This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”), as amended. These statements include, but are not limited to, statements related to our views and expectations regarding our strategy and the performance of our business, our financial results, our liquidity and capital resources, share repurchases and dividends and other non-historical statements. We claim the protection of the Safe Harbor contained in the Private Securities Litigation Reform Act of 1995 for forward-looking statements. Forward-looking statements include those that convey management’s expectations as to the future based on plans, estimates and projections at the time we make the statements and may be identified by words such as “will,” “expect,” “believe,” “plan,” “anticipate,” “intend,” “goal,” “future,” “outlook,” “guidance,” “target,” “objective,” “estimate,” “projection” and similar words or expressions, including the negative version of such words and expressions. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report.

Factors that could cause actual results to differ materially from those in the forward-looking statements include without limitation general economic conditions, including inflation, higher interest rates and potential recessionary pressures; the worsening of the effects from the coronavirus pandemic, (“COVID-19”); COVID-19’s scope, duration, resurgence and impact on our business operations, financial results, cash flows and liquidity, as well as the impact on our franchisees, guests and team members, the hospitality industry and overall demand for and restrictions on travel; our continued performance during the recovery from COVID-19, and any resurgence or mutations of the virus; concerns with or threats of other pandemics, contagious diseases or health epidemics, including the effects of COVID-19; the performance of the financial and credit markets; the economic environment for the hospitality industry; operating risks associated with the hotel franchising business; our relationships with franchisees; the impact of war, terrorist activity, political instability or political strife, including the ongoing conflict between Russia and Ukraine; the Company’s ability to satisfy obligations and agreements under its outstanding indebtedness, including the payment of principal and interest and compliance with the covenants thereunder; risks related to our ability to obtain financing and the terms of such financing, including access to liquidity and capital; and the Company’s ability to make or pay, plans for and the timing and amount of any future share repurchases and/or dividends, as well as the risks described in our most recent Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (the “SEC”) and subsequent reports filed with the SEC. The Company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, subsequent events or otherwise, except as required by law.

We may use our website as a means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD. Disclosures of this nature will be included on our website in the “Investors” section, which can currently be accessed at www.investor.wyndhamhotels.com (http://www.investor.wyndhamhotels.com). Accordingly, investors should monitor this section of our website in addition to following our press releases, filings submitted with the SEC and any public conference calls or webcasts.

References herein to “Wyndham Hotels,” the “Company,” “we,” “our” and “us” refer to Wyndham Hotels & Resorts, Inc. and its consolidated subsidiaries.

BUSINESS AND OVERVIEW

Wyndham Hotels & Resorts is a leading global hotel franchisor, licensing its renowned hotel brands to hotel owners in over 95 countries around the world.

Our primary segment is hotel franchising which principally consists of licensing our lodging brands and providing related services to third-party hotel owners and others.

In the first quarter of 2023, we changed the composition of our reportable segments to reflect the recent changes in our Hotel Management segment due to the exit from the select-service management business, the sale of our two owned hotels and the exit from substantially all of our U.S. full-service management business in 2022. The remaining hotel management business, which is predominately the full-service international managed business, no longer meets the quantitative thresholds to be considered a reportable segment and as a result, we have aggregated, on a prospective basis, such management business within our Hotel Franchising segment.

Rejection of Unsolicited Offer

On October 17, 2023, we announced that our Board of Directors unanimously rejected a highly conditional, unsolicited stock-and-cash proposal by Choice Hotels International, Inc. ("Choice") to acquire all outstanding shares of Wyndham. Our Board of Directors, together with our financial and legal advisors, closely reviewed Choice's latest proposal with a nominal value of $90 per share, comprised of 45% in stock and 55% in cash, and determined that it is not in the best interest of shareholders to accept the proposal.

RESULTS OF OPERATIONS

Discussed below are our key operating statistics, consolidated results of operations and the results of operations for each of our reportable segments. The reportable segments presented below represent our operating segments for which discrete financial information is available and used on a regular basis by our chief operating decision maker to assess performance and to allocate resources. In identifying our reportable segments, we also consider the nature of services provided by our operating segments. Management evaluates the operating results of each of our reportable segments based upon net revenues and adjusted EBITDA. Adjusted EBITDA is defined as net income/(loss) excluding net interest expense, depreciation and amortization, early extinguishment of debt charges, impairment charges, restructuring and related charges, contract termination costs, separation-related items, transaction-related items (acquisition-, disposition-, or debt-related), (gain)/loss on asset sales, foreign currency impacts of highly inflationary countries, stock-based compensation expense, income taxes and development advance notes amortization. We believe that adjusted EBITDA is a useful measure of performance for our segments and, when considered with U.S. Generally Accepted Accounting Principles (“GAAP”) measures, gives a more complete understanding of our operating performance. We use this measure internally to assess operating performance, both absolutely and in comparison to other companies, and to make day to day operating decisions, including in the evaluation of selected compensation decisions. Adjusted EBITDA is not a recognized term under U.S. GAAP and should not be considered as an alternative to net income or other measures of financial performance or liquidity derived in accordance with U.S. GAAP. Our presentation of adjusted EBITDA may not be comparable to similarly-titled measures used by other companies.

We generate royalties and franchise fees, management fees and other revenues from hotel franchising and hotel management activities, as well as fees from licensing our “Wyndham” trademark, certain other trademarks and intellectual property. In addition, pursuant to our franchise and management contracts with third-party hotel owners, we generate marketing, reservation and loyalty fee revenues and cost reimbursement revenues that over time are offset, respectively, by the marketing, reservation and loyalty costs and property operating costs that we incur.

OPERATING STATISTICS

The table below presents our operating statistics for the three and nine months ended September 30, 2023 and 2022. “Rooms” represent the number of hotel rooms at the end of the period which are either under franchise and/or management agreements and properties under affiliation agreements for which we receive a fee for reservation and/or other services provided. “RevPAR” represents revenue per available room and is calculated by multiplying average occupancy rate by average daily rate. “Average royalty rate” represents the average royalty rate earned on our franchised properties and is calculated by dividing total royalties, excluding the impact of amortization of development advance notes, by total room revenues. These operating statistics are drivers of our revenues and therefore provide an enhanced understanding of our business. Refer to the section below for a discussion as to how these operating statistics affected our business for the periods presented.

(a) Excluding currency effects, international RevPAR increased 16% and global RevPAR increased 3%.

(b) Excluding currency effects, international RevPAR increased 27% and global RevPAR increased 7%.

Global rooms grew 3% compared to the prior year, reflecting 1% growth in the U.S. and 6% growth internationally. These increases included strong growth in both the higher RevPAR midscale and above segments in the U.S. and the direct franchising business in China, which grew 4% and 16%, respectively.

Excluding currency effects, global RevPAR for the three months ended September 30, 2023 increased 3% compared to the prior year period, reflecting a decline of 1% in the U.S. and international growth of 16%. The Company had achieved record-breaking RevPAR in the U.S. during the preceding year due to COVID-impacted travel patterns. Our U.S. economy brands gained market share of 100 basis points in the third quarter. Comparing to 2019 to neutralize for COVID-impacted travel patterns, U.S. RevPAR grew 9%, a 30 basis point acceleration from second quarter 2023 growth. The international RevPAR growth was driven equally by stronger pricing power and higher occupancy levels in connection with COVID recovery, and compared to 2019 grew 45% on a constant-currency basis, a 120 basis point acceleration from second quarter 2023 growth.

Excluding currency effects, global RevPAR for the nine months ended September 30, 2023 increased 7% compared to the prior year period, reflecting international growth of 27% as a result of stronger pricing power.

THREE MONTHS ENDED SEPTEMBER 30, 2023 VS. THREE MONTHS ENDED SEPTEMBER 30, 2022

Net revenues for the three months ended September 30, 2023 decreased $5 million, or 1%, compared to the prior-year period, primarily driven by:

• $30 million of lower cost-reimbursement revenues related to the exit of substantially all of our U.S. full service management business, which have no impact on net income; and
• $5 million of lower termination fees; partially offset by
• $20 million of higher marketing, reservation and loyalty revenues primarily related to fees associated with our global conference;
• $5 million of higher royalty fees resulting from RevPAR and rooms increases; and
• $5 million of higher license fees and other ancillary revenues.

Total expenses for the three months ended September 30, 2023 decreased $8 million, or 3%, compared to the prior-year period, primarily driven by:

• $30 million of lower cost-reimbursement revenues associated with the exit of substantially all of our U.S. full-service management business, which have no impact on net income; partially offset by
• $15 million of higher marketing, reservation and loyalty expenses primarily as a result of the costs associated with our global conference and timing of advertising spend; and
• $6 million of higher operating and general and administrative expenses primarily driven by revenue-generating activities.

Interest expense, net for the three months ended September 30, 2023 increased $6 million, or 29%, compared to the prior-year period primarily due to a higher variable interest rate on our term loan A and term loan B in 2023.

Our effective tax rates were 24.3% and 27.3% during the three months ended September 30, 2023 and 2022, respectively. During 2023, the effective tax rate was lower primarily due to a state legislative change that resulted in the release of a valuation allowance and a tax benefit resulting from the release of a foreign unrecognized tax benefit.

As a result of these items, net income for the three months ended September 30, 2023 increased $2 million compared to the prior-year period.

The table below is a reconciliation of net income to adjusted EBITDA.

Following is a discussion of the results of our Hotel Franchising segment and Corporate and Other for the three months ended September 30, 2023 compared to the three months ended September 30, 2022:

(a) For 2023, the Hotel Franchising segment includes the former Hotel Management segment, which is primarily comprised of our remaining international full-service managed business.

Hotel Franchising

Net revenues increased $35 million, or 10%, compared to the third quarter of 2022, primarily driven by:

• $20 million of higher marketing, reservation and loyalty fees primarily reflecting fees related to the global franchisee conference as well as an increase in RevPAR and rooms;
• $6 million of higher license fees and other ancillary revenues;
• $4 million of higher royalties resulting from RevPAR and rooms increases;
• $3 million of management fees primarily from our international full-service management business which were reported within the Hotel Management segment in 2022; and
• $2 million of higher cost-reimbursement revenues in our international full-service managed properties that have no impact on adjusted EBITDA.

Adjusted EBITDA increased $14 million, or 7%, compared to the third quarter of 2022, primarily driven by higher revenues partially offset by (i) a $15 million increase in marketing, reservation and loyalty expenses primarily due to costs associated with our global franchisee conference and (ii) $8 million of higher operating and general and administrative expenses primarily related to revenue-generating activities.

Corporate and Other

Adjusted EBITDA was favorable by $2 million compared to the prior-year period.

NINE MONTHS ENDED SEPTEMBER 30, 2023 VS. NINE MONTHS ENDED SEPTEMBER 30, 2022

Net revenues for the nine months ended September 30, 2023 decreased $88 million, or 8%, compared to the prior-year period, primarily driven by;

• $79 million of lower revenues associated with our select-service management and owned hotel businesses (which we exited in the first half of 2022) of which $29 million represented cost-reimbursement revenues which have no impact on net income; and
• $78 million of lower cost-reimbursement revenues associated with the exit of substantially all of our U.S. full-service management business, which have no impact on net income; partially offset by
• $29 million of higher royalty and franchise fees primarily due to the RevPAR and rooms increases;
• $29 million of higher marketing, reservation and loyalty fees primarily reflecting RevPAR and rooms increases and revenues associated with our global franchisee conference during the third quarter of 2023; and
• $12 million of higher license and other fees.

Total expenses for the nine months ended September 30, 2023 decreased $22 million, or 3%, compared to the prior-year period, primarily driven by;

• $78 million of lower cost-reimbursement expenses associated with the exit of substantially all of our U.S. full-service management business, which have no impact on net income; and
• $65 million of lower expenses associated with our select-service management and owned hotel businesses, of which $29 million represented cost-reimbursement expenses as discussed above; partially offset by
• $62 million of higher marketing, reservation and loyalty expenses primarily as a result of timing of spend and costs associated with our global franchisee conference;
• $35 million from absence of the gain on asset sale in 2022 related to the sale our owned hotel Wyndham Grand Bonnet Creek Resort;
• $9 million of higher operating expenses primarily driven by revenue-generating activities;
• $7 million of higher general and administrative expenses; and
• $5 million of transaction-related expenses primarily related to our term loan refinancing.

Interest expense, net for the nine months ended September 30, 2023 increased $13 million, or 22%, compared to the prior-year period primarily due to a higher variable interest rate on our term loan A in 2023.

Early extinguishment of debt of $3 million in 2023 relates to the refinancing of our term loan B, while the $2 million in 2022 relates to the amendment of our credit agreement and $400 million partial pay down of our term loan B.

Our effective tax rates were 25.7% and 25.8% during the nine months ended September 30, 2023 and 2022, respectively.

As a result of these items, net income for the nine months ended September 30, 2023 decreased $59 million compared to the prior-year period.

The table below is a reconciliation of net income to adjusted EBITDA.

Following is a discussion of the results of our Hotel Franchising segment and Corporate and Other for the nine months ended September 30, 2023 compared to September 30, 2022:

(a) For 2023, the Hotel Franchising segment includes the former Hotel Management segment, which is primarily comprised of our remaining international full-service managed business.

Hotel Franchising

Net revenues for the nine months ended September 30, 2023 increased $102 million, or 10%, compared to the prior-year period, primarily driven by:

• $34 million of higher royalty and franchise fees, primarily reflecting the RevPAR and rooms increases;
• $29 million of higher marketing, reservation and loyalty revenues, primarily reflecting the RevPAR and room increases and revenues associated with our global franchisee conference;
• $16 million of higher license and other fees;
• $12 million of higher cost-reimbursement revenues primarily from our international full-service managed properties that have no impact on adjusted EBITDA; and
• $11 million of management fees primarily from our international full-service management business which were reported within our Hotel Management segment in 2022.

Adjusted EBITDA for the nine months ended September 30, 2023 increased $13 million compared to the prior-year period, primarily driven by the revenue increases discussed above, partially offset by $62 million of higher marketing, reservation and loyalty expenses as well as $10 million of higher operating expenses principally driven by revenue-generating activities and $4 million of higher general and administrative expenses.

Corporate and Other

Adjusted EBITDA for the nine months ended September 30, 2023 was favorable by $1 million compared to the prior-year period.

DEVELOPMENT

On September 30, 2023, the Company's global development pipeline consisted of over 1,930 hotels and approximately 237,000 rooms, representing a 12% year-over-year increase, including 16% growth in the U.S. Approximately 69% of the Company's pipeline is in the midscale and above segments and 58% is international. Additionally, approximately 80% of the Company's pipeline is new construction, of which approximately 34% has broken ground. During third quarter 2023, the Company awarded over 230 new contracts for franchise agreements, an increase of 8%, including 60 new construction projects for its ECHO Suites Extended Stay by Wyndham brand. This brings the total number of contracts awarded for the brand to 265 since its launch, or nearly 33,000 rooms.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Financial Condition

Total assets decreased $23 million from December 31, 2022 to September 30, 2023 primarily related to utilizing our excess cash for share repurchases in 2023. Such decrease in cash was partially offset by higher development advance notes and trade receivables. Total liabilities increased $83 million from December 31, 2022 to September 30, 2023 primarily related to an increase in our debt balance relating to borrowings under our revolving credit facility. Total equity decreased $106 million from December 31, 2022 to September 30, 2023 primarily due to $270 million of stock repurchases and $90 million of dividend payments, partially offset by our net income.

Liquidity and Capital Resources

Historically, our business generates sufficient cash flow to not only support our current operations as well as our future growth needs and dividend payments to our stockholders, but also to create additional value for our stockholders in the form of share repurchases or business investment.

As of September 30, 2023, our liquidity approximated $710 million. Given the minimal capital needs and flexible cost structure of our business, we believe that our existing cash, cash equivalents, cash generated through operations and our expected access to financing facilities, together with funding through our revolving credit facility, will be sufficient to fund our operating activities, anticipated capital expenditures and growth needs.

As of September 30, 2023, we were in compliance with the financial covenants of our credit agreement and expect to remain in such compliance. As of September 30, 2023, we had a term loan B with a principal outstanding balance of $1.1 billion maturing in 2030, term loan A with a principal outstanding balance of $390 million maturing in 2027 and a five-year revolving credit facility maturing in 2027 with a maximum aggregate principal amount of $750 million, of which $110 million was outstanding and $9 million was allocated to outstanding letters of credit.

The interest rate per annum applicable to our term loan B is equal to, at our option, either a base rate plus a margin of 1.25% or the Secured Overnight Financing Rate (“SOFR”) plus a margin of 2.25% plus a 0.10% SOFR adjustment. Our revolving credit facility and term loan A are subject to an interest rate per annum equal to, at our option, either a base rate plus a margin ranging from 0.50% to 1.00% or SOFR plus a 0.10% SOFR adjustment, plus a margin ranging from 1.50% to 2.00%, in either case based upon our total leverage ratio and the total leverage of our restricted subsidiaries. As of September 30, 2023, this margin on our term loan A was 1.75%.

As of September 30, 2023, $1.1 billion of our term loan B is hedged with pay-fixed/receive-variable interest rate swaps hedging our term loan interest rate exposure. The aggregate fair value of these interest rate swaps was a $45 million asset as of September 30, 2023.

As of September 30, 2023, our credit rating was Ba1 from Moody’s Investors Service, BB+ from Standard and Poor’s Rating Agency and BB+ from Fitch Ratings. A credit rating is not a recommendation to buy, sell or hold securities and is subject to revision or withdrawal by the assigning rating organization. Reference in this report to any such credit rating is intended for the limited purpose of discussing or referring to aspects of our liquidity and of our costs of funds. Any reference to a credit rating is not intended to be any guarantee or assurance of, nor should there be any undue reliance upon, any credit rating or change in credit rating, nor is any such reference intended as any inference concerning future performance, future liquidity or any future credit rating. Our liquidity and access to capital may be impacted by our credit ratings, financial performance and global credit market conditions.

CASH FLOW

The following table summarizes the changes in cash, cash equivalents and restricted cash during the nine months ended September 30, 2023 and 2022:

Net cash provided by operating activities decreased $96 million compared to the prior-year period primarily due to a higher use of cash associated with (i) trade receivables as collections patterns return to pre-COVID norms, (ii) development advance notes and (iii) timing of accounts payable.

Net cash used in investing activities was $50 million in 2023 compared to cash provided of $190 million in 2022. The change of $240 million was primarily due to the absence of the proceeds received in 2022 from the sale of our owned hotels and the termination fee from CorePoint Lodging in connection with the exit of our select-service management business.

Net cash used in financing activities decreased $137 million compared to the prior-year period primarily due to $110 million of borrowings on our revolving credit facility, which was used for investments in the business and share repurchases, and a decrease in stock repurchases as the prior-year benefited from the deployment of the proceeds received in connection with the sale of the owned hotels and exit of the select-service management business.

Capital Deployment

Our first priority is to invest in the business. This includes deploying capital to attract high quality assets into our system, investing in select technology improvements across our business that further our strategic objectives and competitive position, brand refresh programs to improve quality and protect brand equity, business acquisitions that are accretive and strategically enhancing to our business, and/or other strategic initiatives. We also expect to maintain a regular dividend payment. Excess cash generated beyond these needs is expected to be available for enhanced stockholder return in the form of stock repurchases or potential acquisitions from time to time.

During the nine months ended September 30, 2023, we spent $28 million on capital expenditures primarily related to information technology, including digital innovation. During 2023, we anticipate spending approximately $35 million on capital expenditures.

In addition, during the nine months ended September 30, 2023, we spent $47 million on development advance notes, net of repayments. During 2023, we anticipate spending approximately $60 million on development advance notes. We may also provide other forms of financial support such as enhanced credit support to further assist in the growth of our business.

We expect all our cash needs to be funded from cash on hand and cash generated through operations, and/or availability under our revolving credit facility.

Stock Repurchase Program

In May 2018, our Board approved a share repurchase plan pursuant to which we were authorized to purchase up to $300 million of our common stock. The Board has subsequently increased the capacity of the program by $300 million in August 2019, $400 million in February 2022, $400 million in October 2022 and $400 million in July 2023. Under the plan, we may, from time to time, purchase our common stock through various means, including, without limitation, open market transactions, privately negotiated transactions or tender offers, subject to the terms of the tax matters agreement entered into in connection with our spin-off.

Under our current stock repurchase program, we repurchased approximately 3.8 million shares at an average price of $71.44 for a cost of $270 million during the nine months ended September 30, 2023. As of September 30, 2023, we had $569 million of remaining availability under our program.

Dividend Policy

We declared cash dividends of $0.35 per share in the first, second and third quarters of 2023 ($90 million in aggregate).

The declaration and payment of future dividends to holders of our common stock is at the discretion of our Board and depends upon many factors, including our financial condition, earnings, capital requirements of our business, covenants associated with certain debt obligations, legal requirements, regulatory constraints, industry practice and other factors that our Board deems relevant.

LONG-TERM DEBT COVENANTS

Our credit facilities contain customary covenants that, among other things, impose limitations on indebtedness; liens; mergers, consolidations, liquidations and dissolutions; dispositions, restricted debt payments, restricted payments and transactions with affiliates. Events of default in these credit facilities include, among others, failure to pay interest, principal and fees when due; breach of a covenant or warranty; acceleration of or failure to pay other debt in excess of a threshold amount; unpaid judgments in excess of a threshold amount, insolvency matters; and a change of control. The credit facilities require us to comply with a financial covenant to be tested quarterly, consisting of a maximum first-lien leverage ratio of 5.0 times. The ratio is calculated by dividing consolidated first lien indebtedness (as defined in the credit agreement) net of consolidated unrestricted cash as of the measurement date by consolidated EBITDA (as defined in the credit agreement), as measured on a trailing four-fiscal-quarter basis preceding the measurement date. As of September 30, 2023, our annualized first-lien leverage ratio was 2.5 times.

The indenture, as supplemented, under which the senior notes due 2028 were issued, contains covenants that limit, among other things, our ability and that of certain of our subsidiaries to (i) create liens on certain assets; (ii) enter into sale and leaseback transactions; and (iii) merge, consolidate or sell all or substantially all of our assets. These covenants are subject to a number of important exceptions and qualifications.

As of September 30, 2023, we were in compliance with the financial covenants described above.

SEASONALITY

While the hotel industry is seasonal in nature, periods of higher revenues vary property-by-property and performance is dependent on location and guest base. Based on historical performance, revenues from franchise contracts are generally higher in the second and third quarters than in the first or fourth quarters due to increased leisure travel during the spring and summer months. Our cash from operating activities may not necessarily follow the same seasonality as our revenues and may vary due to timing of working capital requirements and other investment activities. The seasonality of our business may cause fluctuations in our quarterly operating results, earnings, profit margins and cash flows. As we expand into new markets and geographical locations, we may experience increased or different seasonality dynamics that create fluctuations in operating results different from the fluctuations we have experienced in the past.

COMMITMENTS AND CONTINGENCIES

We are involved in claims, legal and regulatory proceedings and governmental inquiries related to our business. Litigation is inherently unpredictable and, although we believe that our accruals are adequate and/or that we have valid defenses in these matters, unfavorable results could occur. As such, an adverse outcome from such proceedings for which claims are awarded in excess of the amounts accrued, if any, could be material to us with respect to earnings and/or cash flows in any given reporting period. As of September 30, 2023, the potential exposure resulting from adverse outcomes of such legal proceedings could, in the aggregate, range up to approximately $7 million in excess of recorded accruals. However, we do not believe that the impact of such litigation should result in a material liability to us in relation to our financial position or liquidity. For a more detailed description of our commitments and contingencies see Note 12 - Commitments and Contingencies to the Condensed Consolidated Financial Statements contained in Part I, Item 1 of this report.

CRITICAL ACCOUNTING POLICIES

In presenting our financial statements in conformity with U.S. GAAP, we are required to make estimates and assumptions that affect the amounts reported therein. Several of the estimates and assumptions we are required to make relate to matters that are inherently uncertain as they pertain to future events. However, events that are outside of our control cannot be predicted and, as such, they cannot be contemplated in evaluating such estimates and assumptions. If there is a significant unfavorable change to current conditions, it could result in a material impact to our consolidated results of operations, financial position and liquidity. We believe that the estimates and assumptions we used when preparing our financial statements were the most appropriate at that time. These Condensed Consolidated Financial Statements should be read in conjunction with our 2022 Consolidated Financial Statements included in our most recent Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (the “SEC”) and any subsequent reports filed with the SEC, which includes a description of our critical accounting policies that involve subjective and complex judgments that could potentially affect reported results.

We use various financial instruments, including interest swap contracts, to reduce the interest rate risk related to our debt. We also use foreign currency forwards to manage and reduce the foreign currency exchange rate risk associated with our foreign currency denominated receivables and payables, forecasted royalties, forecasted earnings and cash flows of foreign subsidiaries and other transactions.

We are exclusively an end user of these instruments, which are commonly referred to as derivatives. We do not engage in trading, market making or other speculative activities in the derivatives markets. More detailed information about these financial instruments is provided in Note 11 - Fair Value to the Condensed Consolidated Financial Statements. Our principal market exposures are interest rate and currency exchange rate risks.

We assess our exposures to changes in interest rates utilizing a sensitivity analysis. The sensitivity analysis measures the potential impact in earnings, fair values and cash flows based on a hypothetical 10% change (increase and decrease) in interest rates. Our variable-rate borrowings, which include our term loan, a portion of which has been swapped to a fixed interest rate, and any borrowings we make under our revolving credit facility, expose us to risks caused by fluctuations in the applicable interest rates. The total outstanding balance of such variable-rate borrowings, net of swaps, was $541 million as of September 30, 2023. A hypothetical 10% change in our effective weighted average interest rate on our variable-rate borrowings would result in a $3 million increase or decrease to our annual long-term debt interest expense, and a one-point change in the underlying interest rates would result in approximately a $5 million increase or decrease in our annual interest expense.

The fair values of cash and cash equivalents, trade receivables, accounts payable and accrued expenses and other current liabilities approximate their carrying values due to the short-term nature of these assets and liabilities.

We have foreign currency rate exposure to exchange rate fluctuations worldwide, particularly with respect to the Canadian Dollar, the Chinese Yuan, the Euro, the Brazilian Real, the British Pound and the Argentine Peso. We anticipate that such foreign currency exchange rate risk will remain a market risk exposure for the foreseeable future.

We use a current market pricing model to assess the changes in the value of our foreign currency derivatives used by us to hedge underlying exposure that primarily consists of our non-functional-currency current assets and liabilities. The primary assumption used in these models is a hypothetical 10% weakening or strengthening of the U.S. dollar against all our currency exposures as of September 30, 2023. The gains and losses on the hedging instruments are largely offset by the gains and losses on the underlying assets, liabilities or expected cash flows. As of September 30, 2023, the absolute notional amount of our outstanding foreign exchange hedging instruments was $150 million. We have determined through such analyses that a hypothetical 10% change in foreign currency exchange rates would have resulted in approximately a $3 million increase or decrease to the fair value of our outstanding forward foreign currency exchange contracts, which would generally be offset by an opposite effect on the underlying exposure being economically hedged.

Argentina is considered to be a highly inflationary economy. As of September 30, 2023, we had total net assets of $2 million in Argentina.

Our total market risk is influenced by a wide variety of factors including the volatility present within the markets and the liquidity of the markets. There are certain limitations inherent in the sensitivity analyses presented. While probably the most meaningful analysis, these “shock tests” are constrained by several factors, including the necessity to conduct the analysis based on a single point in time and the inability to include the complex market reactions that normally would arise from the market shifts modeled.

(a) Disclosure Controls and Procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive and principal financial officers, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rule 13(a)-15(e) of the Exchange Act). Based on such evaluation, our principal executive and principal financial officers concluded that our disclosure controls and procedures were effective and operating to provide reasonable assurance that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and to provide reasonable assurance that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.

(b) Internal Control Over Financial Reporting. There have been no changes in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) during the period to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. As of September 30, 2023, we utilized the criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

The discussion of our business and operations should be read together with the risk factors contained in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 (“Annual Report”), filed with the Securities and Exchange Commission, which describe various risks and uncertainties to which we are or may become subject. These risks and uncertainties have the potential to affect our business, financial condition, results of operations, cash flows, strategies or prospects in a material and adverse manner.